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Unstable equilibrium in 2010

Robert Peston | 19:26 UK time, Wednesday, 30 December 2009


Prognosticating about the ensuing 12 months was like shooting fish in a barrel over the past few years.

The big facts about the noughties were first that there was too much cheap money sloshing about, and then - inevitably - that there was too little.

So my predictions for 2006, 2007, 2008 and 2009 were "boom, overheating, crunch and bust", respectively.

Wobbly me

But for the first Hogmanay in ages, I have little confidence in what the coming year will bring for business, for savers, for investors and for borrowers.

Why am I so wobbly? Well, it is because of the manner by which we avoided a depression in the UK, the US and much of Europe.

With banks, non-financial businesses and households all de-leveraging, all trying to reduce their huge and unsustainable debts, a massive economic heart attack was avoided by a reduction in official interest rates to almost zero, to ease the squeeze on the private sector, and by increases in public spending.

Or to put it another way, any fall in private-sector indebtedness has been offset by a rise in public-sector indebtedness.

Which means that viewed across all economic sectors, the UK and the US are still submerged in debt: the aggregate borrowing of households, companies and government is equivalent to more than three times the value of everything we produce, still greater than at any point in peacetime history.

Patient creditors?

If you add to that the liabilities of banks that should be viewed as unsustainable because they are provided or guaranteed by the state, then the indebtedness of much of the West can be seen as greater still.

So the big intolerably uncertain question for Britain and America (and for Greece, Ireland and others) is can we reduce our debts in an orderly way - one which would be gruelling for us, as we save more and consume less, but not unbearable?

Or will our creditors lose patience and demand their money back - in which case we would have to pay massively more for credit while draconian cuts in government and household spending would be forced on us?

To put it more succinctly, we are balanced precariously.

The most likely tilt on the axis takes us to an indeterminate period of low growth, which won't be painless - because our standard of living and public services would stagnate and unemployment would continue to rise.

But we cannot discount a violent tilt in an altogether more unpleasant direction, where sterling would plummet and the cost of borrowing for government and for us would soar.

What's worse, our fate is not wholly in our control.

We could be a domino knocked over in a chain reaction started by the default of another too-indebted nation.

Or we could be victimised by investors if the current recovery in property and share prices came to a sticky end, since that would lead to further losses for our still rickety banks.

Or inflation could rise faster than the Bank of England expects, which would force it to put up the official interest rate in a manner that dangerously sucked out all that additional cash given by it and the Treasury to consumers over the past year.

Or we could become a pariah for investors if the resolve of the next British government to reduce public-sector borrowing was doubtful.

To put it another way, we're probably in for a period of low growth and slow steady recovery - but a further shock cannot be wholly discounted.

What price shares and gold?

There are also huge uncertainties about the outlook for assorted financial markets.

Take share prices. Even after rising 50% from their lows of early 2009, they don't look particularly expensive on the basis of historical averages for the relationship between prices and earnings or between prices and assets.

But those historical averages may well have been massively distorted by the share-price inflation of the bubble of the late 1990s and the cheap-money bubble of the mid-noughties.

So if those speculative bubbles are viewed as aberrations, shares may be expensive.

Or take gold.

If we are in for a period of slow steady recovery, in which interest rates rise, gold is greatly over-valued.

But if the dollar and sterling were to plunge - well, gold would glisten even more than it has.

Two 'certainties'

Is there no forecast that can be made with confidence?

I suppose there are just two about which I feel a bit more certain.

The first is that the Chinese currency must surely rise. China's authorities will surely be unable to keep the cork in the bottle, when their economy looks so much stronger than the US's.

Second, even without a sterling crisis, the interest rates paid by the British government must surely increase and the price of gilts (of all maturities) must surely fall.

Gilt prices have been boosted by investors' curious conviction that lending to governments like ours was safer than lending to banks or to the private sector.

But now that the penny has gradually dropped that the banks and public sector are more or less indistinguishable, it has gradually become a tiny bit cheaper and easier for banks to borrow and it will probably become harder and more expensive for governments to borrow.

Update 1145: A number of you spotted a typo which I have now corrected. I wrote that the "price of gilts... must rise", when I meant to say that they must "fall". Sorry for the confusion.

Will business rescue us?

Robert Peston | 12:08 UK time, Wednesday, 23 December 2009


The great jolt to confidence caused by last autumn's banking crisis, and our collective uncertainty about what the future holds, has prompted vast numbers of us to endeavour to reduce our indebtedness.

As Stephanie has mentioned, official statistics indicate a sharp increase in the rate of saving by British households, after years in which we accumulated unprecedentedly large debts.

Suddenly that all-time record 175% (or so) ratio of household indebtedness to disposable income feels like a dreadful millstone.

Of course, thanks to the munificence of the Bank of England in slashing Bank Rate and creating £200bn of new money, it is not the interest payments that are bearing down on us, but the overall indebtedness.

The principal on the household debt (still greater than our GDP) may seem unbearable at a time when expectations for growth in our earnings and in the value of our assets have been very considerably diminished.

That said, it is not impossible that rising interest rates could at some point put a squeeze on consumers' capacity to spend, as the Bank of England has helpfully pointed out in its latest Financial Stability Report.

This shows that if inflation bubbled up and the Bank's Monetary Policy Committee felt obliged to increase interest rates to the levels of just a few years ago, households would be paying out eye-watering amounts of their earnings to service the interest on their debts (with Bank Rate at 5%, households on average would be allocating between 11% and 14% of their income to interest payments, which would be a very high proportion by all historical standards).

That said, and as the minutes published this morning of the last MPC's last meeting make clear, there's no great likelihood of Bank Rate rising sharply any time soon.

However bosses of retailers tell me that they are not expecting 2010 to be a return to boom times. And no-one should expect a great splurge of consumer spending to power us out of our economic torpor.

So what will be the source of the UK's economic recovery?

Well it's plainly not going to come from the public sector, with government indebtedness rising at an unsustainable rate and the main parties engaged in an argument about the scale and pace of spending cuts, not the inevitability of such cuts.

Any oomph would probably have to come from private-sector businesses, especially investment by them.

So just how likely is it that industry and services will be our salvation?

Well let's start with the anecdotal evidence.

As is my wont this time of year, I've asked a bunch of business leaders - in an informal way - what they expect from 2010.

None were preparing for a massive increase in demand for their stuff. And although they assumed that the recession was over in a technical sense, they did not expect the recovery to feel massively better for themselves or their staff than the depressed conditions of the past year or so.

On employment, they were not prepared to commit that there would not be further redundancies.

Some admitted that they had been "hoarding" labour, keeping people on in the hope of better times - but there could come a moment (perhaps early in the new year) when those hopes were dashed and there would have to be a further round of job losses.

As for investment, business leaders said they were behaving (unsurprisingly) rather like households: they would rather reduce indebtedness or accumulate cash, than make substantial financial commitments.

Those views are consistent with the Bank of England agents' survey [360 KB],
which describes the outlook for investment as flat. It paints a picture of businesses that plan investment increases being offset by those preparing for cuts, with small and medium size businesses tightening belts more than big ones.

That's not particularly cheering, coming - as the Bank points out - after a fall in investment spending in the UK which has been significantly greater than during past recessions.

For those of a pessimistic cast of mind, these trends are probably too reminiscent of the sustained falls in business investment that prevented Japan from growing for more than a decade.

And as in Japan, it is the hard numbers on lending to business that should probably be given greater weight than what business leaders actually say.

In Britain, the credit statistics are dire.

The annual rate of lending to business has been falling at an ever greater rate, month after month, to a decline of 7.6% in October (the last month for which figures are available).

This squeeze is a mixture of less credit being available, especially from non-British lenders, and of reduced demand for credit.

It is true that some businesses are choosing to issue bonds and new shares rather than borrow from banks. However the net overall supply of finance to business remains flat, even including the proceeds of those fund-raisings.

Also, certain really important sectors - notably manufacturing - have raised next to nothing from capital markets while also massively reducing their borrowing from banks.

There was a tiny glimmer of recovery in lending just by British banks to business reported for November by the British Bankers' Association.

However this figure may be a rogue, since it is skewed by a slightly odd bounce in borrowing by "real estate, renting and other business services", while manufacturers continue to borrow less.

My take on what's happening goes like this: stronger businesses are frequently choosing to save rather than spend; banks are refusing to provide new finance to weaker businesses: and the very weakest businesses are being kept on life support by banks which may not wish to endure the political and financial pain of putting too many of them into administration all at the same time.

As of now, an investment-led British economic revival does not look imminent.

New ice age for bankers

Robert Peston | 09:15 UK time, Friday, 18 December 2009


For all the furore about Alistair Darling's bonus super-tax, and for all the disclosure overnight by Deutsche Bank that it will spread the pain across all staff and shareholders around the world and not just in the UK, there is a much bigger threat to business-as-usual for banks and bankers.

Alistair DarlingThe international rulemaking body for the banking industry, the Basel Committee on Banking Supervision, has proposed a series of reforms that would change the nature of banking in a profound way (Strengthening the resilience of the banking sector [282KB PDF]).

Some will mutter about stable doors and horses: it was the inadequacy of the existing Basel rules which provided dangerous incentives to banks to take the crazy risks that have mullered the global economy.

But be in no doubt. Although its reform paper, "Strengthening the resilience of the banking sector", may seem technical and obscure, it would turn a particular kind of high-paying, securities trading, global megabank - the institutions that created and defined the boom-and-bust conditions of the past decade - into an endangered species.

If I were running Barclays, or Deutsche Bank, or JP Morgan or even Goldman Sachs, I would be more than a little anxious about the cumulative impact of the Basel Committee's recommendations on the additional high-quality capital that banks would be required to hold, the liquid assets they need to accumulate and also - oh yes - the rewards banks can distribute to employees and shareholders.

Mr Darling's raid on their cash boxes looks trivial by comparison: it's just a one-off; Basel is forever.

The Basel reforms would make it prohibitively expensive for banks to do all that wheeling and dealing in securities and derivatives that yielded bumper profits and bonuses in the boom years and brought the world to the brink of depression last autumn.

Perhaps most significant would be the proposal to limit the ability of banks to pay out bonuses to staff and dividends to shareholders as and when their respective capital resources approach the minimum allowed.

The nightmare before Christmas for bankers is the tape on page 70 of the report, which sets out the new global incomes policy for them.

It will be seen by bank boards and owners as an infringement of their basic right to pay themselves what they want and when they want.

The consequences would be profound not only for the banking industry but also for the economy - which is why they will be phased in over years.

They are likely to mean that far less credit to households and non-financial businesses will be provided by conventional banks, because the cost to banks of providing credit in any form will rise.

They are also likely to force a mass exodus from banks of the more entrepreneurial, brainier, traders and financial engineers - who may either go for real jobs in the real economy (is that such a terrible idea?) or will create all manner of new-fangled financial institutions, which won't take retail deposits, won't be banks in a technical sense, and won't be subject to such onerous regulation and supervision.

Yes, the Basel plans almost certainly mean there'll be another great sprouting of hedge funds and alternative investment vehicles.

You can decide whether that's a good thing or a bad thing.

By the way, if you want a bit more granularity on how and why an ice age just arrived for banks and bankers, look no further than the recent Financial Services Authority discussion document on reinforcing the capital strength of British banks and also today's Financial Stability Report from the Bank of England [3.95Mb PDF].

The FSA estimates that financial institutions in the UK will need to raise an additional £33bn of capital to meet new rules out of the European Union designed to reduce the riskiness of their trading activities and of securitisation (of turning loans into tradeable assets).

Now the big point about that £33bn is that it does not include the additional requirements that will be imposed by the new Basel framework. The £33bn is just a beginning.

Which gives the banks two choices.

They can try to raise the £33bn and whatever else is subsequently demanded of them. Or they can massively reduce their trading activities - which seems the more likely outcome.

Can they turn to the Bank of England for a shoulder to cry on.

Not likely.

It makes this helpful point to banks which - it agrees - are still chronically short of capital: "reducing staff costs [at banks] by around one tenth and dividend payout rates by around a third would allow UK banks to increase retained reserves by close to £70bn over the next five years".

Crikey: five years of stunted bonuses! Grown bankers will weep.

BA: Stress addict

Robert Peston | 16:05 UK time, Thursday, 17 December 2009


For British Airways' owners and managers, today's court injunction against the Christmas strike is temporary relief not proper recovery: BA still needs to resolve its dispute with cabin crew over staffing levels and pay.

British Airways planesThe airline cannot really escape the painful truth that many of its people feel spurned and alienated. Even if there were procedural irregularities in the ballot, staff voted decisively to strike.

So it's one more problem to sort, for a business that often seems addicted to crisis - many of which are in the territory of industrial relations - but somehow keeps functioning.

Most of us however would have had something of a nervous breakdown, confronted with quite the challenges its management is currently grappling.

Quite apart from managers' assessment that the productivity of cabin crew is well below that of competitors, BA is struggling against a collapse in revenues and a massive pension deficit.

In just the first six months of this year, BA's sales fell £650m - which are the worst trading conditions it has ever experienced.

And at a time when it is incurring huge losses, it has to find the funds to fill a huge hole in its two pension funds - which it earlier this week disclosed as £3.7bn - bigger than the market value of the business.

That is a real debt, which BA has to honour - and the hole may well turn out to be substantially bigger, because the Pensions Regulator has said it believes the airline should use more conservative assumptions when measuring these deficits.

It is no exaggeration to say that BA's future may hinge more on the Pensions Regulator's final verdict than how it finally resolves its argument with cabin crew.

BA believes that its best hope of coping with prolonged economic turbulence is to marry the Spanish airline Iberia, but Iberia has a right to dump BA at the altar if it perceives the pension fund deficits to be unbearably huge.

BA seems confident that it won't be jilted - presumably because it assumes the Pensions Regulator would not wish to be seen to be undermining the supposedly happy-ever-after nuptials.

But it is important to note that Iberia's positive noises about the deficits relate only to the numbers agreed by BA and the trustees of the schemes, which is a bit like giving a verdict on the pleasantness of a flight long before the plane has landed.

Update 1635: And to compound BA's woes, the uncertainty of whether and when there may be a strike will dissuade many from booking with BA in the coming weeks.

Banks try to deal away bonus tax

Robert Peston | 17:24 UK time, Wednesday, 16 December 2009


A number of banks do not apparently believe that the super-tax on bonuses is real.

I have it from impeccable sources that several of them have rung up their mates and contacts in 10 Downing Street, the Treasury and BIS (Department for Business, Innovation and Skills), to ask if they can be let off the 50% one-off bonus tax.

In return they would make a one-off contribution to some worthy project or other, or just pay over a wodge of money unconnected to the value of bonuses they actually want to pay.

Ministers and officials are nonplussed.

They take the view that taxes are to be paid, rather than bargained away.

What's going on is not quite the same as offering a bag of cash to the tax collector in a democratically challenged fledgling state - but it's not far off.

Anyway all the signs are that the Treasury will not be moved and that banks are going to have to like or lump the tax.

In evidence to the Treasury select committee today, Alistair Darling shut down any prospect that paying bonuses in shares or deferring payment will reduce liability by a penny.

There is no bonus deal to be done.

If banks want to pay big bonuses, they will have to hand over to taxpayers 50% of the value of those bonuses.

Can banks save the planet?

Robert Peston | 12:18 UK time, Wednesday, 16 December 2009


If the current entente between G Brown and N Sarkozy ruled the world, we would be well on the way to a global tax on financial transactions.

In a recent joint statement, the unlikely double act said that the "revenues from a global financial transactions tax" - perhaps better known as a Tobin tax - could help defray the costs of transition to a low-carbon economy, especially for developing countries.

Nicolas Sarkozy and Gordon Brown

It's a live issue at Copenhagen, partly because - I suppose - the notion of a Tobin tax to pay for ecological rehabilitation is something of a blast from the past, a golden oldie beloved of the green movement.

You might call it a bit of ideological recycling.

So the Treasury's latest thinking on such a transaction tax is worth knowing about, you'd think.

And as luck would have it, the Treasury has published a paper - called "Risk, Reward and Responsibility: the financial sector and society" - which is about how superfluous financial dealings could be taxed and also how banks could be forced to make a greater contribution to the costs of clearing up after them.

Some would say (but I could not possibly comment) that the paper is a bit disappointing - because it is a miscellany of unconnected arguments rather than a rigorous analysis of the costs and putative benefits of either levying a worldwide tax on financial dealing or of charging banks for the de facto insurance against collapse that taxpayers provide to them.

What's most interesting - I guess - is the political statement represented by the paper, which is that such levies are very much on the government's agenda.

That said the Treasury is clear that this is not an area for unilateral national action, that such taxes or charges won't be imposed by the UK unless other G20 nations do the same (10 Downing St is a little less robust on this all-or-none approach).

The Treasury fears - after the horse has bolted, some might say - that an exclusively British charge on banks would cause undue harm to our financial services industry.

So it would need to be confident that Switzerland and the US would implement equivalent taxes before putting its paws into our banks' pockets again.

Hmmm. How likely is it that tax-loathing Switzerland, Singapore and the US will ever sign up for more taxes on banks, even to save the planet?

Well it would be a bit more likely if proponents such as the Treasury could furnish detail on what would be taxed, how and why.

The gaping hole in the Treasury's paper is any analysis of which financial transactions may be gratuitous - or "socially useless" to use Adair Turner's resonant phrase - or even potentially destabilising for the economy.

If such transactions could be identified with confidence, then taxing them might be harmless to the prospects for sustainable economic growth or even a good thing.

All that the Treasury trots out are the same old stats showing the exponential growth of financial transactions in recent years.

For example, it mentions that the outstanding gross value of over-the-counter derivatives rose from less than $100 trillion dollars in 1998 to almost $700 trillion in 2008 (or more than 10 times the value of everything the world produces per annum).

Now it's not ludicrous to conclude that a big chunk of those transactions were either designed to transfer wealth in a sophisticated gull from naïve investors to clever bankers, or to avoid tax, or to manufacture fees out of products with no serious underlying purpose.

It is also arguable that a proportion of those deals have not had a net smoothing effect on markets as a whole but have increased the volatility of share prices, and commodity prices and debt prices - in a way that may actually have damaged the interests of genuine wealth creating companies in the real economy, by making it harder for them to plan.

But although such intuitions may be reasonable, intuitions are no basis for levying a new tax.

What would be required is solid data.

It would be useful to know how many of these derivative transactions were 'naked' speculation rather than hedging of real-economy deals by non-financial businesses.

Take credit derivatives, those notorious de facto insurance contracts against debt defaults.

Only a minority of the $50 trillion odd of these that are extant are hedges for actual holders of debt. But what is the precise size of what some would see as these legitimate hedges, as opposed to the more speculative deals?

Similarly, what proportion of all derivatives have as their primary purpose tax avoidance?

Unless and until such data can be collected, the debate on whether a transaction tax could or should be implemented is probably going nowhere.

The point being that not all financial innovation is either harmful, fatuous or a gull.

In this context it is worth noting the almost hysterical reaction of big non-financial companies to the supposed cost implications of relatively anodyne proposals to route all derivative contracts through so-called central counterparties.

You can imagine the response of such businesses - not banks, but energy companies, telecoms outfits and so on - to the idea that they would be hit by the Tobin tax.

Which is not to say that we won't eventually see a transaction tax whose proceeds can be deployed for a grand social purpose.

But the tax is so amorphous right now that - surely - it can't be the financial glue at Copenhagen to unite developing and developed nations, even if it is a bond between France and perfidious Albion.

How to super-tax the real culprits

Robert Peston | 16:27 UK time, Tuesday, 15 December 2009


The chancellor said in his pre-Budget report speech that his motive for levying a one-off super-tax on banks that pay big bonuses was to deter them paying out precious resources to employees and encourage them instead to "rebuild their financial strength and increase their lending".

Alistair DarlingTo be clear, if it was his only aim to strengthen banks in this way then probably the easiest route would have been to oblige banks to pay 100% of their bonuses in shares or equity capital, rather than cash (which, as it happens, is Tory policy).

So presumably at least part of Mr Darling's aim was to raise some wonga for the public purse and spank the banks for having to be bailed out by all of us.

Even so, it really is odd that the draft legislation for the new tax explicitly says that it is payable by all sorts of financial institutions which are not what most of us would think of as banks - such as stockbrokers and interdealer brokers (see my note of yesterday).

And I am unclear whether this oddity is deliberate or the undesirable consequence of drafting unprecedented new tax law in a great rush.

That said, changing just one word in the draft legislation would probably remove most of the apparent anomalies.

The point is that Clause 19 section 1c defines a "UK resident bank" liable to the tax as a company that either takes deposits "or" carries on dealing in investments as an agent or principal.

Which is why non-deposit takers such as Tullett and assorted other brokers are liable to the super-tax - although on the face of it they are not in the category of banks which the chancellor wants to discourage from paying bonuses (unlike many of the giant banks, they did not indulge in the reckless behaviour that mullered themselves and the economy).

But these putative innocents would be protected from the tax if the "or" was changed to an "and".

This one word change would mean that only deposit-takers which also operate as investment banks and financial dealers would pay the punitive tax.

The likes of Barclays and RBS would pay the special levy, but Tullett and many other smaller monoline financial brokers and agents - which have neither been offered nor have taken succour from taxpayers - would be untouched.

So why is there an "or" instead of an "and"? Why is the universe of super-tax payers broader than deposit-takers which are also dealers in investments?

I presume that there is some firm or category of firm that the Treasury and HMRC want to tax which would otherwise go untaxed.

But who would dodge the bullet if the definition of the relevant firms were narrowed?

I wondered whether the Treasury feared that pure investment banks such as Goldman Sachs would be excluded.

But if the "or" became an "and", Goldman would still have to cough up, because it is an authorised deposit taker in the UK.

I have to say that I am a bit stumped.

For a moment, I had pondered whether the Treasury was using the draft legislation to feel its way towards a formula for a permanent broader financial transaction tax that it would then endeavour to sell to the other leading economies of the G20.

But its work on that is separate (I will take a look at the Treasury's ideas for such a permanent financial industry tax or for a financial system quasi insurance levy in a later note).

I think therefore the best one can say is that the super-tax is a slightly amorphous organism which is still evolving - and probably needs to find its final shape fairly sharpish, before too many brokers and bankers have relocated to low-tax Zug.

PS. Just in case any of you have noticed the remarks made today by Royal Bank of Scotland's chairman Sir Philip Hampton that "there have been no threatened mass resignations of the board", his statement is completely consistent with what I wrote last week (see "RBS board to quit if chancellor vetoes £1.5bn in bonuses").

Bonus tax: Innocents punished?

Robert Peston | 13:47 UK time, Monday, 14 December 2009


Tullett Prebon has not requested or received a penny of taxpayers' money as part of the bail-out of banks over the past two years.

And yet it is liable to pay the chancellor's new super-tax on bonuses, or so it believes.

City workers walking past Tower Bridge in LondonIts chief executive, Terry Smith (a former colleague of mine in a past life) is in no doubt that the draft legislation relating to the super-tax catches Tullett, together with a whole host of other City firms which are neither banks nor obviously culpable for the excesses that led to last autumn's global banking crisis.

Tullett is a broker which matches buyers and sellers of financial products.

Banks are often its clients. But to hold Tullett responsible for the reckless risk-taking of its banking clients would be like holding Boots responsible for customers who ignore the instructions on the drugs it sells.

And nor is Tullett an unlucky exception. Stockbrokers, money managers and a host of other firms that don't look like, act like or quack like the supposedly malevolent banks are liable for the super-tax as per the draft legislation.

This looks like a mistake, since the Treasury originally told me that only authorised banks would be liable.

There must be a reasonable chance that the rules will be changed to exclude the likes of Tullett.

But damage may have been done. Some of Tullett's London-based staff have over recent months become increasingly persuaded that the UK provides a hostile climate for them.

Tullett has told them it will help them move to its overseas offices, if they want to relocate.

Such emigration won't undermine the British economy. But it looks like gratuitous harm.

Update 15:25: By the way, anyone from Tullett - or any such financial institution - who went into exile today would not save his or her firm any of the one-off super-tax. It's too late for that.

Quitting the country would simply be a protest and/or a prophylactic against future UK tax liabilities.

And as for clarifying whether Tullett and its ilk are ultimately going to pay the tax, in some ways that's more a matter for HMRC rather than the Treasury - in that the role of HMRC at this stage of proceedings is to interpret and implement the revealed preference of the chancellor (whatever that may be).

Gilts: The fine line between hope and despair

Robert Peston | 10:39 UK time, Friday, 11 December 2009


There's an unmistakeable smell of the 1970s about finance, politics and economics: the City recovering from a banking crisis; a super-tax on wealthy bankers; fears that international investors will stop lending to the British government; excitable chatter about the likelihood of a hung parliament.

All we need now is a power cut and I would swear I had been transported back to my teens (if only).

Alistair DarlingAgainst that slightly discombobulating backdrop, what has been bugging me ever since Alistair Darling announced his one-off tax on banks paying big bonuses is whether there would be any impact on the government's ability to sell £225bn of gilts to investors this year (and a similar amount next year).

Or to put it another way, would the Treasury pay for its raid on bankers pay by being forced to pay more when borrowing in the form of sales of government bonds?

It would certainly be wrong to attribute yesterday's fall in the price of gilts to bankers' retribution.

That was caused by bond investors' disappointment that the chancellor in his pre-Budget report did nothing to accelerate a reduction in the UK's record peacetime public-sector deficit.

This is how Michael Saunders, an economist at Citigroup, put it:

"The PBR offers little or no coherent plan to get the UK back to a sustainable fiscal stance over the next few years...There are still no plans for public spending after 2010/11, merely forecasts. This is not just a linguistic difference: it signals that the government has not yet decided on its public spending intentions for those years. This implies that the UK also has no plans to get back to fiscal sustainability."

Saunders adds: "The UK's fiscal route will, if followed, probably also lead to the UK losing its top-notch [credit-rating] status, for the first time ever."

It's only a view, and there are others who argue that the UK's AAA credit rating - which allows the government to borrow at very low interest rates - is safe, at least for the time being. Moody's, for example, said overnight that the outlook for the AAA ratings of the UK and the US was "stable", even though earlier this week the ratings agency said that both countries may "test the AAA boundaries".

That said, the clever old Debt Management Office - which organises the sale of gilts for the Treasury - will not be properly testing investors' appetite to lend to HMG till 6 January.

Treasury building

Which is when the next sale of conventional gilts takes place (there will be a small sale of index-linked stock next week, but that probably won't give much of a guide to how the market feels about the UK's credit-worthiness).

The point is that governments typically have an uneasy relationship with big financial institutions: there is a relationship of patron to client, in that governments provide lots of valuable business to banks and have ultimate responsibility for how they are regulated; but governments which borrow are not all-powerful, in that they require the goodwill of banks and investors to borrow what they need.

If bankers are grumbling about having their bonuses slashed by Mr Darling, are they really going to be enthusiastic salesmen for the bonds he wants to sell?

Finance isn't just about numbers and rates of return; it's also about emotion. And if the City were to be alienated from the incumbent government, that would not be healthy for either side.

That said, there is a semi-rational connection between the bonus super-tax and downgrades of the UK's fiscal prospects, which is that if genuine wealth-creating firms and individuals were to move abroad, that would lead to a shrunken tax base in the UK.

However the notion that the bonus tax would have a material impact on the British economy would of course be absurd.

But what also strikes me is how delicately balanced the UK is between vicious cycle of decline and virtuous circle of recovery.

For those who want cheering up, take a look at an analysis in this month's Financial World magazine by the noted monetary economist and former member of the Monetary Policy Committee, Charles Goodhart.

He believes the time has come for the Bank of England to cease helping the government to borrow, to stop buying gilts, to end the quantitative easing programme of converting government debt into money - for fear that to extend the QE programme beyond the first quarter of 2010 would pump up asset prices to dangerous levels (and see my note A bubble or 'stubble' or our own design).

As he implies, all else being equal, an abrupt halt to the Bank of England's acquisition of gilts could spark something of a crisis for the Treasury, because the Bank's purchases have almost exactly matched the volume of gilts being sold by the Treasury (though to be clear, the Bank buys in the market, not directly from the government).

Will conventional bond investors take up the slack after the Bank of England withdraws from the market? What will happen to the price of gilts and the interest rate paid by the Treasury in those circumstances?

It's an alarming prospect.

Except that all else isn't equal. Goodhart points out (as too has Stephanie Flanders in her blog) that - as luck would have it - big banks are about to be forced by the Financial Services Authority to make substantial purchases of gilts, to rebuild their liquid resources and make them less vulnerable to the kind of cash crises they suffered last autumn.

He says:

"Commercial banks have built up huge unused reserves at the Bank of England. It hardly takes a genius to recognise that three requirements can be simultaneously realised:

1) fund the public-sector deficit in 2010-11;
2) return the Bank of England's swollen balance sheet to normality;
3) rebuild the liquid assets ratio of UK banks."

Or to put it another way, commercial banks - the likes of Royal Bank of Scotland and Barclays - will be the big buyers of gilts after the Bank of England becomes a net seller.

Or will they?

I am not so sure. Because the Financial Services Authority has told me that - although it is obliging banks to increase their holdings of top quality government bonds as a bulwark against unexpected swings in funding needs - it recognises the dangers in forcing banks to buy vast numbers of gilts too quickly.

Here's the thing: by all historical standards, the price of gilts remains very high; so it would be madness to force British banks to buy tens of billions of pounds of UK government debt at the top of the market, because that would make the banks vulnerable to capital-eroding losses as and when the price of gilts returns to more normal levels.

In other words, the supposed happy coincidence between the government's funding needs and prudential regulation of commercial banks is not quite what it seems. If the Financial Services Authority had its way, it might actually be deterring banks from buying gilts at the moment of the Treasury's greatest need, because this would be when gilts were most over-priced.

That said, even if the banks were to devour gilts to the tune of tens of billions of pounds, that would not restore the health of the public finances, as Goodhart concedes.

He says: "immediately after the general election, whoever wins must execute a credible plan to restore the UK's fiscal position to a sustainable level".

Which is becoming a boringly familiar refrain.

Time to hug Goldman?

Robert Peston | 17:59 UK time, Thursday, 10 December 2009


Goldman Sachs, the world's most successful investment bank - the highest form of life in the liberal-financial-market jungle - has this afternoon announced changes to its 2009 comp programme.

Goldman Sachs office, New York"Comp" or "compensation" is bankese for pay. Which always seems to me an example of doublespeak that only a banker could construct - because some would argue that it's the rest of us who should be compensated for the mess the bankers have made of the economy, not the bankers who need compensating for dreaming up schemes to disguise the riskiness of their practices from regulators and investors.

Anyway Goldman's board has decided that the firm's "entire 30-person management committee" will "receive 100% of their discretionary compensation in the form of 'shares at risk'" which can't be sold for five years.

Arguably this will better align the interests of Goldman's bosses with the 80% of stockholders who don't work for the firm.

But it's not obvious that it conspicuously aligns Goldman's senior partners pay with the preferences of the rest of the world's citizens.

Goldman's banking aristocracy will still be pocketing bonuses worth up to $50m or $60m each on the back of profits earned from the exceptionally buoyant trading conditions created by governments' and central banks' exceptional measures to resuscitate economies.

Naturally their inability to turn that into hard cash right now will spark some sympathy in a few of us.

But others might well say the principle that a partner should hold stock till he or she leaves the firm is a pretty sound one, for all seasons.

In fact, keeping shares till exit has been the norm at Goldman since time immemorial anyway.

And as for the absence of any cash bonus, well for Goldman's top bods cash was already only about 20% of typical payouts.

So it looks to me as though this isn't much of a revolution and the ancient regime looks undisturbed.

Time to hug a banker?

Robert Peston | 10:02 UK time, Thursday, 10 December 2009


If I were running a big international bank with substantial operations in London (no need to cheer that I'm not, thank you very much) I'd be a little bit depressed that the government's super-tax on bonuses has not been attacked on principle by either of the main opposition parties.

Canary Wharf

It's true that Vince Cable, the Lib Dem's economics force-of-nature, grumped yesterday about the levy, but only that he felt it had more holes for bankers to slip through than vintage Emmental.

Having read the HMRC's technical note [128KB PDF] on it this morning, I'm not sure he's quite right. That said, the low yield expected by the Treasury from the tax - some £550m - is something of a puzzle.

As I mentioned in a note last week (RBS board to quit if chancellor vetoes £1.5bn in bonuses), Royal Bank of Scotland was expecting to pay bonuses just to its investment bankers of £1.5bn for their performance in 2009.

On the reasonable assumption that the bulk of the £1.5bn would consist of bonuses greater than the tax threshold of £25,000, RBS's bonuses would deliver more than £550m in tax just on their own.

What's more, RBS was by no means planning to be a particularly generous bonus-payer.

Inevitably RBS will now suspend its bonus plans, till it can evaluate what its competitors will do.

But the Treasury's forecast of what it expects to receive from the tax implies either that it expects banks to massively reduce their bonus payments or to find ways of avoiding the new tax on them.

Actually there is a further possible explanation - which is that a truly astonishing number of those earning the big bucks in the City are not resident here for tax purposes.

Certainly many international banks have a policy of rotating their top staff around the world so that they are never in one place long enough to become liable for local taxes.

Even so, the point of greater interest for those who run big banks is surely that no politician with clout - except for the Mayor of London, Boris "the bank lover" Johnson - felt able to stand up yesterday to defend the banks and their bonuses. And even Johnson's defence was feeble by his standards.

So some bankers may rage at what they see as an infringement of their Magna Carta right to pay themselves what they like, but it should give them pause for thought that they have become so marginalised in our society that even the most ardent supporters of liberal capitalism will not rally to their cause.

To put it mildly, this is not healthy. It can't be a recipe for either economic success or social stability that the guardians of our savings and the providers of finance for households and businesses are untouchable outcasts.

We would all benefit from a rapprochement.

The question is how it can be achieved.

Banks and bankers could retaliate by taking themselves to financial centres where they'll be more welcome.

And, of course, there are such places.

But Britain is not the only country mulling a one-off tax on bonuses and may not be the last to impose one.

It is striking that the French President, Nicolas Sarkozy, today put his name alongside Gordon Brown's to an article in the Wall Street Journal which says "we agree that a one-off tax in relation to bonuses should be considered a priority, due to the fact that bonuses for 2009 have arisen partly because of government support for the banking system".

What Gordon Brown and Alistair Darling would dearly love to see would be the American's imposing some kind of cap on 2009 bonuses.

Well the history of bitter rivalry between Wall Street and the City of London would suggest that's not very likely - especially with Congressional elections looming and candidates so dependent on contributions from the financial sector.

It would be wrong however to characterise the US as the home of anything-goes remuneration: the US Treasury's so-called "pay czar", Kenneth Feinberg, has imposed pretty swingeing restraints on the remuneration of employees in businesses that have received substantial amounts of government assistance.

What's to be done?

Well a number of bank chief executives and chairman have said to me in private that they accept the argument that their profits for 2009 contain a substantial windfall element, generated by the exceptional measures taken by central banks and finance ministries to limit the damage from a recession partly caused by reckless bankers.

Perhaps if a few of them said this more loudly in public, and created the conditions for a voluntary moratorium on big bonuses by the industry, they'd be allowed out of the gulag of their own construction.

What would be in it for the bankers? Well political leaders might I suppose adapt one of David Cameron's catchphrases and call on us all to hug a banker.

Just think of the catharsis, as we wept together over the economic vandalism of the past few years - for which we may all share some responsibility (although some are plainly more to blame than others).

Will taxing bonus pools spur lending growth?

Robert Peston | 14:57 UK time, Wednesday, 9 December 2009


For financial markets, the pre-Budget report has been something of a non-event.

Sterling is a little weaker today, as are the prices of UK government bonds.

Alistair DarlingThere's no great surprise there: we've known for months that Britain's public finances are a horror story, and what the chancellor said today neither added or subtracted gore to any great extent.

Or to put it another way, the UK is neither closer or further from losing its AAA credit rating, or suffering a sterling crisis, or being unable to borrow from international investors - or any of the other possible nightmarish next chapters in this epic of Western economies that have borrowed too much.

If business in general is likely to feel a bit let down it is that National Insurance is rising to support increased spending on schools and hospitals rather than to shrink the deficit.

The point is that most in the private sector would like to see the size of the state shrink as a share of GDP from the current high peace-time levels, along with public-sector borrowing, to help create the economic space for the private sector to grow.

As for the new levy on banks that pay bonuses of greater than £25,000, the Treasury estimates that it will affect 20,000 UK-based bankers.

That's a lot of bankers.

The Treasury is calling it a "bank payroll tax" - and says that the 50% tax on bonus pools will not be deductible when banks compute their profits for taxable purposes.

So they'll have to pay their mainstream corporation tax and their new payroll tax.

The tax comes into force tonight and will apply until 5 April 2010.

Interestingly, if banks were to defer bonus payments till 6 April, the exchequer would still receive a lot of extra revenue - because that's when the top rate of income tax rises from 40% to 50%.

So if banks are planning to pay out £6bn in aggregate in bonuses for their performance in 2009, which they are rumoured to be doing, and they were to defer all payment till the new tax year, individual bankers would have to shell out an extra £600m in tax (presumably the Treasury believes that bonuses will be much less than £6bn in practice given that it thinks the 50% payroll tax will raise little more than £500m).

In other words, those banks that are desperate to pay big bonuses have some discretion over whether they pay the extra tax or whether their employees do so.

As one fund manager said to me today, "the Treasury is being bloody clever".

Actually, the Treasury has also made it clear that it may extend the liability period for the temporary payroll tax from 5 April, if other curbs that it plans on banks' remuneration practices are not by then implemented.

Here's one final thought, courtesy of that money manager I mentioned earlier.

He thinks that the payroll tax could be good for the economy, because it will encourage banks to build up their capital rather than pay bonuses, which in turn will encourage them to lend and invest a great deal more, to increase their profitability.

Maybe this is wishful thinking on his part.

But he thinks the tax could encourage banks to play a bigger role in sustaining an economic recovery - because only in doing so will they be able to generate the substantial revenues that will allow them before too long to pay those fabulous bonuses again.

How the bonus tax will work

Robert Peston | 08:46 UK time, Wednesday, 9 December 2009


The chancellor will at lunchtime announce a super-tax on banks that pay big bonuses (no surprise there, given how much I have been banging on about it).

It will have an impact on hundreds of banks operating in the UK of all nationalities.

The special one-off levy will make it very expensive for those banks to pay big bonuses to thousands of bankers based in Britain.


Later today, in the pre-Budget report, the chancellor will say that if banks pay bonuses to individual bankers over a specified fairly low level - perhaps £10,000 - that will trigger a special one-year-only tax for those banks.

The tax payable will be calculated by adding together all those big bonuses and then levying a charge on the aggregated sum of those big bonuses.

The tax rate for the bank on that pool of bonuses would be more than 50%.

Which will make it very expensive for the banks to pay the bonuses.

So although the Treasury expects to raise a few hundred million pounds from the levy, it would not be wholly surprised if the take were less substantial - in that the banks could decide this is not a great year to pay bonuses.

What is particularly striking is the sheer number of banks - hundreds - that will be affected: the tax will hit British banks as well as overseas banks with subsidiaries or branches in London.

It means that banks from Britain's Barclays, through France's BNP Paribas, to Goldman Sachs of the US will all be affected.

It will cause a furore in the City, because no other country has announced such a super tax on bonuses.

What's more, the chancellor is likely to say that if he sees banks systematically taking clever steps to avoid the tax - by temporarily pushing up the basic pay of employees, for example - he would expect the Inland Revenue to be aggressive in preventing that and would not hesitate to legislate to close down the avoidance schemes.

This is a big moment for the City of London.

Some will say that banks and bankers are rightly being punished for the economic and financial havoc they caused by their reckless lending and investing.

Others will warn that the competitiveness of a vital British industry, finance, may be harmed - and that we could all be the poorer.

UPDATE, 11:11: Perhaps the best way to see the proposed super-tax on bonus-paying banks is as a semi-voluntary windfall tax.

If banks choose to pay big bonuses, they will pay the tax. If they decide against paying big bonuses, they won't pay it.

The chancellor is in effect saying that much of banks' profits in 2009 have been a windfall, or a gift from the state generated by the exceptional financial and economic measures taken by the Bank of England and the Treasury to resuscitate the economy and financial system.

These profits should be deployed to strengthen the banks by being retained as capital, Mr Darling is insisting. But if the banks choose to reduce their profits - and tax - by paying out a proportion of the profits as fat bonuses, then he will get his mits on a fat slug of this putative windfall through his new one-off super-tax.

So there is a stark choice for banks' boards and their shareholders.

They can ask their top executives to make a financial sacrifice for a year for the financial health of the bank. Or the banks can suffer a big financial hit so that the members of the bond or forex desks can buy another Ferrari or several.

It's a tough one.

What fascinates me is how the tax will affect the behaviour of banks and bankers.

The Treasury clearly believes it has constructed the tax in a way which creates little incentive for individual bankers to move abroad or move firms - since the tax would be paid by the bank not the banker.

And since the tax will last no longer than a year, it should not be sufficient to persuade the banks themselves to re-locate to Paris, Frankfurt or Geneva - which are still at a disadvantage to London in respect of skills and tech infrastructure.

What's more Dubai isn't quite the competitive threat as a financial centre that it might have appeared to some a year or so ago.

So the City will doubtless scream blue murder about the tax, because banks and bankers are being hit where it hurts most - in the pocket.

But the bankers to whom I've spoken in the past few days about all this say that the City has survived much worse.

Defending a super-tax on banks

Robert Peston | 17:17 UK time, Tuesday, 8 December 2009


The last time this government or any government levied a windfall tax, it justified the tax - in a legal, ethical and political sense - by explicitly allocating the proceeds to a specified project perceived to be in the public interest.

Gordon Brown as chancellor in 1997That was in 1997, when Gordon Brown was just a few weeks into what would be a record-breaking tenure as chancellor. And the tax was the windfall tax on the privatised utilities, with the proceeds reserved for the so-called New Deal measures for reducing youth and long-term unemployment.

Specifying the proceeds in this way was essential: the Treasury received strong advice that it meant the tax would be less vulnerable to legal challenge.

As you know, I expect Mr Brown's successor as chancellor, Alistair Darling, will tomorrow announce an exceptional one-off tax on banks or bankers, designed to reclaim for taxpayers most of what banks pay out in bonuses to their investment bankers (see my assorted notes of Sunday and Monday).

And I would be very surprised if history wasn't repeated, with the expected revenues reserved for supposed good works.

Now some of you may believe that preventing bankers' from enriching themselves out of taxpayers' emergency support for the economy is a public service in its own right.

But the truth is that the proceeds of the fiscal spank for bankers - some few hundred million pounds - will vanish without trace in the Treasury's financing requirements for this year and next.

The proceeds will be about 0.5% of what the government is borrowing this year, or a tiny beauty spot on the public sector's bloated indebtedness.

Which is partly why it would make sense for the chancellor to be able to say that the forced sacrifice of bankers would be the salvation of this or that deserving cause.

So who will be the beneficiaries of the Treasury smash-and-grab on bonuses?

Well this is a government that likes to sing its anthems more than once (to put it mildly). So I would not be surprised to see a new New Deal (so to speak) for young people, given that youth unemployment is way above the national average.

The rather less likely alternative would be the National Investment Corporation, the state-controlled bank for providing "growth capital" to small businesses which is the progeny of Gordon Brown and Peter Mandelson.

Funnily enough, the Treasury's paper on the Asset Protection Scheme - which I wrote about yesterday - confirmed that Royal Bank of Scotland and Lloyds have each agreed to contribute £100m to it.

But even with that bit of generosity from the almost-nationalised RBS and the semi-nationalised Lloyds, the National Investment Corp would still be about £800m short of its target for funds.

So if other banks don't stump up voluntarily, perhaps the super-tax can be re-calibrated to fill the gap.

Update 2017: For what it's worth, I'm sure my first instinct is correct - that the proceeds of the banks' super-tax will be deployed (or hypothecated) for tackling unemployment among young people.

UPDATE, 11:11: Perhaps the best way to see the proposed super-tax on bonus-paying banks is as a semi-voluntary windfall tax.

If banks choose to pay big bonuses, they will pay the tax. If they decide against paying big bonuses, they won't pay it.

The chancellor is in effect saying that much of banks' profits in 2009 have been a windfall, or a gift from the state generated by the exceptional financial and economic measures taken by the Bank of England and the Treasury to resuscitate the economy and financial system.

These profits should be deployed to strengthen the banks by being retained as capital, Mr Darling is insisting. But if the banks choose to reduce their profits - and tax - by paying out a proportion of the profits as fat bonuses, then he will get his mits on a fat slug of this putative windfall through his new one-off super-tax.

So there is a stark choice for banks' boards and their shareholders.

They can ask their top executives to make a financial sacrifice for a year for the financial health of the bank. Or the banks can suffer a big financial hit so that the members of the bond or forex desks can buy another Ferrari or several.

It's a tough one.

What fascinates me is how the tax will affect the behaviour of banks and bankers.

The Treasury clearly believes it has constructed the tax in a way which creates little incentive for individual bankers to move abroad or move firms - since the tax would be paid by the bank not the banker.

And since the tax will last no longer than a year, it should not be sufficient to persuade the banks themselves to re-locate to Paris, Frankfurt or Geneva - which are still at a disadvantage to London in respect of skills and tech infrastructure.

What's more Dubai isn't quite the competitive threat as a financial centre that it might have appeared to some a year or so ago.

So the City will doubtless scream blue murder about the tax, because banks and bankers are being hit where it hurts most - in the pocket.

But the bankers to whom I've spoken in the past few days about all this say that the City has survived much worse.

We're all bankers now

Robert Peston | 17:07 UK time, Monday, 7 December 2009


In my wilder imaginings over the years about the future of the public sector, it never occurred to me that one day as a taxpayer I would be financially liable for the overdrafts on 3.2 million UK retail bank accounts, £10bn of loans to British small businesses and a further £10bn of UK residential mortgages provided to 70,000 home owners.

Treasury buildingBut that is what the Treasury has unveiled today as just some of the loans and investments that we as taxpayers have insured under the Asset Protection Scheme.

This is the financial arrangement that helps to prop up Royal Bank of
Scotland: it's the supposedly clever wheeze that allowed the humungous ailing bank, which is 70% owned by the state, to survive without having to be fully nationalised.

The broad terms of the APS are that the public sector would become liable for 90% of losses on £280bn of loans and investments, after RBS has first incurred a £60bn loss on those loans and investments.

Put simply, it's a way of transferring financial risk from the private sector, or RBS and its shareholders, to the public sector, or you and me.

All of which has been known for weeks.

What we didn't know was precisely what we were insuring.

Well today the Treasury told us that - inter alia - we are now liable for £10bn of loans to small British businesses, £32bn of British property finance, £39bn of derivatives, £28bn of finance for highly indebted big companies, and so on.

If you are a sucker for horror stories, you can live out more of the gory detail of RBS's dodgy loans and investments that we've taken under our stretched belt by clicking here [3.98KB PDF].

But for me there is one big theme that emerges, which is the hopeless inadequacy of Royal Bank's risk controls under its previous management, led by Sir Fred Goodwin.

The sheer diversity of the assets that we as taxpayers are being forced to underwrite, to prevent RBS from going bust, is what stands out: everything from the complex investments manufactured by investment bankers to plain vanilla personal loans.

What is also dispelled today is the notion that a disproportionate share of Royal Bank's horrible loans and investments were contributed by the rump of the Dutch bank ABN, which RBS foolishly acquired in the autumn of 2007.

It is clear that at least half of the poor loans and investments insured by taxpayers - maybe a little bit more than that - were originated by Royal Bank, rather than ABN.

Or to put it another way, what we can now see is that one reckless bank with lamentable risk controls, RBS, bought the worst bits of another one, ABN.

This was a marriage made in bankers' hell.

There is another striking disclosure today - which is that the Treasury doesn't have a conspicuous amount of trust for RBS in the partnership they have formed.

It has made sure that the Asset Protection Agency - a new body set up to manage the Treasury's interest in the Asset Protection Scheme - can appoint so-called "step-in managers" to seize control of insured loans and investments if losses on those loans and investments are greater than expected.

What the Treasury fears is that RBS will have little incentive to limit losses on these insured assets, once it has burned through the £60bn loss that must first fall on RBS and its shareholders before taxpayers start to feel pain.

Or to put it another way, the Treasury has itself taken out a bit of insurance against the great danger inherent in the Asset Protection Scheme, which is that RBS will lose any incentive or will to make any recoveries from the lousy credit it extended before the bubble burst.

Will biffing bankers also biff Britain?

Robert Peston | 09:48 UK time, Monday, 7 December 2009


With the exception of the Mayor of London, Boris Johnson, and a number of "Londonophiles" (probably not a real word, but you know what I mean), there is a wide perception that the UK economy became too dependent on the City and financial services.

Measuring that dependence is not enormously easy, however.

Banks at Canary Wharf, LondonAs a share of GDP, financial services contributes somewhere between 8% and 12% (according to which survey you believe).

More germanely perhaps, in the boom years before 2007 the City was directly responsible for about a third of all the UK's economic growth and a disproportionate share of tax revenues (whose best measure, perhaps, is the black hole that began to open in the public finances when a host of finance-related activities stopped yielding as much some two years ago).

But if the City became too puffed up and important to the UK's capacity to generate wealth, there are two ways of correcting that imbalance - which some might characterise as the "road to prosperity" and the "road to ruin".

The route to sustainable growth would be to build up other productive parts of the UK economy - manufacturing, the creative industries, tech, pharma and so on - as fast as possible.

Penury, of course, would stem from a rapid shrinkage in the City that was not counter-acted by growth elsewhere.

So the chancellor, Alistair Darling, will be acutely aware in calibrating his super-tax on investment bankers' bonuses that it should not lead to the wealth-generating City baby being thrown out with the stinking bathwater of excessive bonuses.

If top bankers were rational, they would not migrate to Zug or Hong Kong on the basis of a one-year super tax on their bonuses.

But a few will flee, because they are disgruntled by what they increasingly see as a hostile climate in the UK.

Which is why, as I mentioned in my note last night, the shadow chancellor George Osborne chose in the end not to take the initiative in proposing such a super-tax on bonuses, even though he has looked in detail at imposing a special levy on banks' distributed profits, or the combination of bonuses and dividends.

In fact George Osborne gave a very public nod in the direction of a bonus and dividend tax in his autumn speech to the Conservatives' annual conference.

And as a senior Tory said to me, he is not going to fall into the trap of publicly opposing such a super-tax as and when it is announced, because many traditional Tories are bonding with Labour voters in their visceral contempt for bankers and their bulging bonuses.

Osborne and Darling both believe that banks should not be paying big bonuses on the back of profits that they perceive as a gift from taxpayers (see my note "Banks face windfall tax" for more on this).

They want those profits retained in banks' balance sheets, to strengthen them.

That said - as the deputy governor of the Bank of England, Paul Tucker, has argued - there is a very strong case for banks (rather than bankers) to pay a levy (an annual one, probably) for the insurance we now know that they have to have from taxpayers: banks survived last autumn because taxpayers provided essential capital that the markets would not provide; banks should now pay for permanent access to this "capital-of-last-resort" facility.

But that's another story for another day. The government does indeed want such a charge to be imposed on banks, but won't go alone in introducing it. It is therefore swinging into international diplomacy mode to persuade the White House in particular that some kind of tax on financial transactions is good for the world.

For now what interests me is the behavioural impact of a one-off super-tax on bonuses.

As I've already mentioned, such bonuses will largely be paid in shares this year - for reasons of balance-sheet prudence ordained by the Financial Services Authority.

But if those bonuses are taxed at say 80%, it would be rational for the owners of the banks - the big investment institutions - to instruct banks' boards not to pay bonuses at all, because to do so would be to squander precious share capital.

In other words, such a super-tax might have the desired political effect of preventing bonuses from being paid.

But there might be almost no revenue from it for the Exchequer (even less than the few hundred million pounds expected by the Treasury).

Some would say, however, that the revenue implications are less important than the distributive and social justice of biffing bonuses.

Which may be so. But within any individual bank there'll be lots of individual shouts of "it's not fair".

Think about a typical trading desk at Goldman Sachs, for example: the British contingent, and the few others domiciled here for tax purposes, would pay the tax; but the non-domiciled Asians, Americans, French and Germans would not.

So if a bonus super-tax were introduced, we would be disproportionately hurting our own, as it were.

A bonus super-tax

Robert Peston | 22:44 UK time, Sunday, 6 December 2009


The windfall that the chancellor wants to capture is bankers' bonuses, as I said in my last note.

Alistair DarlingSo what he has in mind - and what may be announced in Wednesday's pre-Budget report - is not a classic windfall tax, which would be levied on banks' profits.

Instead it would be a super-tax on bonuses over a certain level paid to British-based investment bankers.

The advantage of taxing these bonuses are first that they are likely to be pretty popular with more-or-less everyone apart from the bankers, if opinion polls are to be believed.

But also, as I mentioned in my previous note, taxing bankers rather than banks would not weaken the banks themselves, at a time when they need to accumulate capital.

That said, taxing the bankers may not be cost-free for the UK.

The UK may have become excessively dependent on the City and financial services, but it would not be great for the economic prospects of the UK if wealth-creating bankers and financial institutions emigrated to rival financial centres - for fear that the UK is becoming irredeemably hostile to them.

Which is why George Osborne, the shadow chancellor, did not pre-empt the government by announcing that a Tory administration would impose such a super-tax - although he did consider announcing an intention to impose a one-off special tax on both big bonuses and dividends.

That said if the government announces such a super-tax, the Tories won't oppose it.

As one senior Conservative told me, such a super-tax might be bad for the UK, but it would not be great for the Tories to oppose a tax that may give a nice warm feeling even to many of their core supporters.

Banks face windfall tax

Robert Peston | 16:38 UK time, Sunday, 6 December 2009


The Treasury is preparing to levy a windfall tax or super-tax on British-based banks, which could be announced as soon as Wednesday in the pre-Budget report and would raise considerably more than £1bn a year for two or three years (but see below for an important update, which discloses a refinement in Treasury thinking - such that the tax would be for one year only and would raise several hundred million pounds, or less than £1bn).

It is not 100% certain that such a tax will be announced, because there are formidable practical obstacles.

But if it is imposed, it won't just apply to UK banks such as Barclays, HSBC and Royal Bank of Scotland. The British arms of overseas firms, such as Goldman Sachs, JP Morgan and Deutsche Bank, would also be liable.

However, several ministers and officials have told me that the government is determined to extract revenue from banks for taxpayers and simultaneously prevent the banks from awarding substantial bonuses to their employees.

"It is a matter of justice," said one minister. "Investment banks are making exceptional profits as a result of the intervention of government and the Bank of England to limit the economic damage from the mess caused by those very same banks. So it would be outrageous if they paid those profits to employees and bonuses. We are determined to
prevent that."

One route being considered is to levy a super-tax on bankers who receive bonuses over a certain low level. Another is to massively increase the employers' National Insurance charge on banks that pay big bonuses, or to tax the profits of investment banks directly.

Whatever tax is finally chosen and announced (if any) would not last longer than two or three years.

The Treasury believes that the City of London would not lose massive numbers of employees or business to rival financial centres if a super-tax lasted just a few years.

However, it fears there would be serious damage to Britain's financial services industry if banks or bankers based in the UK were perceived to pay much more tax than those elsewhere.

There are many practical difficulties with imposing a super-tax, not least of which is skirting European Union prohibitions on taxation that discriminates against individual companies.

But probably the biggest obstacle to such a windfall tax or super-tax on the banks is that the Treasury does not want to be extracting precious cash from banks at a time when they need to strengthen themselves by accumulating capital as a buffer against future losses.

"We can't impose a tax that weakens banks capital," said a member of the government. "Anything we do must be neutral in respect of their capital resources."

That said, the banks are more-or-less being coerced by the authorities into paying out their bonuses in shares, because this actually creates capital for banks.

So if there were a super-tax on bonuses awarded in shares, that would not erode banks' capital resources.

Even the Chairman of the Financial Services Authority, Lord Turner, has pointed out that it looks unfair to many that banks are planning to pay out big bonuses on the back for profits that are the exceptional consequence of evasive action taken by the government and the Bank of England to limit the depth of the recession suffered by
the UK.

The argument runs that reckless lending and investing by the banks precipitated the financial crisis of 2007 and 2008 which was an important cause of the recession.

And not only have banks been bailed out by taxpayers to the tune of £850bn - in the form of loans, guarantees, insurance and investment - but they have also seen their profits artificially boosted by the indirect consequences of the slashing of interest rates and the creation of £200bn of new money.

For example, big companies have paid off old debt and taken on new debt to take advantage of the massively reduced interest rates - thus generating big fees for investment banks.

Also, the sharp falls in the dollar and sterling which the Bank of England and US Federal Reserve have engineered to an extent have created massive trading and hedging opportunities for banks.

"The fact is that we have gifted vast profits to the banks as a result of our actions," said a minister. "If they were using those profits simply to strengthen themselves that would be okay. But what we can't accept, and what society can't accept, is that they are using those profits to pay enormous bonuses."

In the longer term, the prime minister and chancellor want a permanent levy on banks transactions, a so-called Tobin tax. However they recognise that it would be devastating for the City if such a tax were imposed unilaterally by the UK, so the Treasury is preparing a paper which it will use as the basis for trying to secure agreement from the
G20 leading economies for such a tax.

Update 2026: Ministers have refined their thinking on the windfall tax. It now looks as though it will be a one-off, lasting no more than a year. And the revenue from it is likely to be a few hundred million pounds - in other words, less than one billion.

And, for the avoidance of doubt, it will be aimed at curbing bonuses deemed to be excessive.

How HBOS escaped closure

Robert Peston | 09:35 UK time, Friday, 4 December 2009


According to the National Audit Office, the Treasury believed at the beginning of October 2008 that Royal Bank of Scotland's "capital position was reasonably strong but noted that the bank was increasingly dependent on short-term wholesale funding".

nao_hbos226.jpgThe implication is that the Treasury was a benighted passenger on the good ship Titanic, as it ploughed inexorably towards the iceberg.

Hmm. If that were so, it would be profoundly shocking.

Because at that stage of last autumn, a few weeks after Lehman Bros went down, financial markets were in meltdown.

I know that by then even the myopic Financial Services Authority, the City watchdog, was aware that Royal Bank's dependence on short-term funding - which was the consequence of its ill-judged takeover of the rump of ABN - was potentially lethal.

And the FSA would also have calculated that RBS had far too little capital: the bank had lent and invested a perilous 50 times its capital resources, well over twice what most would deem to be the prudent leverage multiple.

So RBS wasn't just vulnerable to falling apart if it hit an iceberg. If someone sneezed on it, the bank might have collapsed.

That said, I have a clear recollection that the Treasury was in secret already working on a recapitalisation plan for the big banks. In other words, the internal Treasury paper alluded to by the NAO seems inconsistent with the work going on at the Treasury at that moment.

It's all a bit odd.

But maybe in all the fog and mayhem, it was not by then clear to Treasury ministers and officials which of Barclays and RBS was the more rickety.

Certainly it took quite some time for ministers to be persuaded that Barclays would be able to raise the capital it needed from commercial sources, and would not require a substantial investment from taxpayers.

nao_hbos226b.jpgSomewhat less jarring - but still shocking - is the NAO's disclosure that "as HBOS's position weakened on 16 September [2008], the Treasury considered informing HBOS that it would be closed to new business, unless a rescue could be arranged".

Closing a bank to new business is curtains.

Guess what? On the night of 16 September, HBOS went into panic mode in its negotiations with Lloyds on a takeover.

And (for the record) it was on the morning of 17 September 2008 that I disclosed Lloyds was in advanced merger talks with HBOS (see my note of that morning, Lloyds to buy HBOS).

It was obvious at the time that HBOS was in a desperate hurry to agree a deal. But it was impossible to know quite how desperate it was.

For Lloyds' shareholders, the NAO's disclosure is another bitter pill.

If they weren't asking it already - which of course they have been - Lloyds' shareholders will today ask why their board agreed to pay a penny for a bank, HBOS, which was apparently just hours from being banned from doing any new business.

Public servants on $20m a year

Robert Peston | 09:45 UK time, Thursday, 3 December 2009


Twice a year, the chairmen and chief executives of Europe's biggest banks gather in secret for a chinwag about matters of collective interest.

They meet under the auspices of a hush-hush club formed after World War II, whose operations are so mysterious that even the grandees who attend it seem unclear what it's really called.

One bank supremo told me its name was the Instituts d'Etudes Financieres or some such; another that it went by the moniker IIEB.

Either way, what I can tell you is that it attracts a pretty high calibre of banker - and that its last meeting was just a few weeks ago at the plush London hotel, Claridges, where the main item on the agenda was the topical question of bankers' bonuses.


Present were - inter alia - Stephen Green of HSBC, Philip Hampton of RBS, Marcus Agius of Barclays and David Mayhew of JP Morgan Cazenove, and their counterparts from Germany, Italy, France and so on, including the grands fromages from Soc Gen and BNP Paribas.

Now, let's be clear: the idea that banks would ever collude to solve a mutual problem would be an outrageous and unwarranted slur. Collusive tendencies may have been in bankers' DNA two decades ago, but these days (who can doubt?) it's all about compete or die.

That said, they would dearly love a collective agreement to cease hostilities on bankers' pay, because they know there is a one-to-one correlation between each million pound bonus they pay and damage to their reputations.

But although they explored whether they could reach an entente on capping bankers' pay, they abandoned the ambition as a hopeless cause. Why? Because they can't get the Americans into the room.

This is what the head honcho of one giant bank said to me:

"The Americans will never agree to put a limit on bonuses. They regard it as a fundamental right to pay as much as they like. And if we cap our pay here in Europe, while they operate in the free market, well we'll all be dead."

Funnily enough, I heard a very similar lament from a senior member of the government the other day, who told me that the great failure of the recent G20 meetings of the world's most powerful governments is that they didn't agree a moratorium of at least a year on all bonus payments by banks.

As he said, there's a very strong intellectual case for saying no bank should pay a bonus for 2009, which is that:

a) none of them would be alive today in the absence of that $15 trillion bailout I've been boring on about, and

b) a vast proportion of their 2009 profits stem from the exceptional measures taken by governments and central banks to minimise the impact of a recession precipitated (in part) by banks' greed-fuelled recklessness.

So surely world leaders could have won a good deal of popular support, while not committing a heresy on the religion of capitalism, by simply instructing their banks that all their more senior employees would have to rub along on their six figure salaries for a year, with no bonuses paid.

Why didn't this happen? "The Americans would never sign up", says my well-placed informant.

Which is a bit odd, because in the US right now "Goldman Sachs" is a byword for qualities (in the public mind at least) that most of us would rather not have.

Alistair DarlingOne consequence of this failure to put in place an official bonus hiatus is that our chancellor of the exchequer finds himself in the hideous position of having to either approve Royal Bank's planned bonuses of between £1.5bn and £2bn, or veto them and risk seeing the RBS board announce a collective intention to resign (see my note of yesterday).

So what is the going rate for RBS's top profit generators? Well last year, when the bonus pool was £900m for the investment bank, several hundred of its executives earned more than a million pounds each.

At the top end, an RBS currency trader in New York (at its Greenwich subsidiary) took home $20m and a commodity trader (in a joint venture that's now being sold) was paid $40m.

The past year has been a bumper one for forex and government bonds, which are the areas where RBS is particularly strong. So quite a number of its top traders will be expecting $10m plus.

And let's not kid ourselves that RBS would be paying this out of some act of charity. It in fact would argue that it doesn't pay top dollar.

Here is what many bankers have told me that they regard as extraordinary: it was Alistair Darling's choice to become the grand arbiter of how many forex traders can take home a seven-figure wedge (does he wear a hair shirt, as well?).

Even though the state (that's us) owns 70% of RBS (rising to 84.4%, in an economic sense), the chancellor didn't have to take direct responsibility for what the bank pays out in bonuses.

He could have maintained the not-quite fiction - or what he has argued for a good year - that RBS is an independent commercial entity, and the Treasury is more-or-less just another shareholder among many (albeit a humungous shareholder).

Or to put it another way, he could have said what is actually true in company law and the stock exchange listing agreement, that bonuses are a matter for RBS's board.

But presumably he didn't think that would wash with voters, even if it's actually true. So he insisted, when agreeing to recapitalise RBS (yet again) through the Asset Protection Scheme, that he would take a formal new power to authorise the total amount of bonuses paid and also the form of the bonus payments.

Form will be less problematic: RBS has already agreed, under pressure from the Financial Services Authority, that most of the payments will be in shares and that recipients will not be able to get their mits on all the shares till a number of years have elapsed.

But size of the so-called bonus "pool" will not be uncontentious. As I mentioned yesterday, Royal Bank has told Alistair Darling that it would intend to pay about 50% more in bonuses than last year in its investment bank, or between £1.5bn and £2bn in bonuses for the bank as a whole.

And its reasoning is simple: considerably more than that, it believes, would be wiped from the value of the organisation in a permanent sense, if it were not tot pay competitively and if its top profit-generators were to desert to competitors.

Which is why the directors received unambiguous legal advice that if they were prevented by the chancellor from fulfilling their duty (their fiduciary duty) by providing the rewards commensurate with preserving the wealth of the shareholders, they would have to quit.

It is clear that earlier this year, the Treasury accepted the argument that RBS had to pay the going rate. When RBS announced in February that it had reached agreement on its approach to pay and rewards for 2008-9, a press release from the bank also said that the government had conceded that the bank would pay "competitively with other international banks" for the current year.

What is unclear is what status that agreement now has, in the light of the chancellor's new power to approve or veto bonuses. Arguably, it may limit his ability to block payments he deems excessive.

To state the obvious, it is a mess, and surely only the hardest hearted would fail to feel a scintilla of sympathy for the chancellor, in this nightmarish predicament of his own making, should he sanction the twenty million dollar payments, or muller the bank? What a choice.

Update 16:20: Just in case anyone doubts Royal Bank of Scotland's contention that pay is a highly competitive issue for all banks, Barclays is proving its rival's point - by whacking up the non-variable element of the remuneration of staff at Barclays Capital, its investment bank.

This will lead to pay increases of around £75,000 per year for large numbers of its executives, according to sources - who don't shy away from the notion that some staff will receive 50% pay rises

What's more, the pay rise is back-dated to earlier this year, so will generate a tidy cash lump for thousands of employees - which is handy given that cash bonuses at all banks (as opposed to bonuses paid in shares) have been squished as a result of the international agreement reached by G20 governments earlier this autumn.

Barclays' line is that it has to do this, because its rivals have already increased the base salary of their executives and therefore Barcap was finding it difficult to attract or retain staff.

What's more, Barclays claims that by pushing up salaries it is only doing what G20 governments have asked it to do, by shifting the weight of pay from the variable portion (called bonuses in normal language) to fixed.

Mind you, I don't suppose ministers would have wept if Barclays had achieved the same outcome by slashing bonuses rather than hiking up fixed pay.

Presumably Barclays has not timed this pay rise to lend weight to Royal Bank's argument with the Treasury that it has to pay whopping bonuses to maintain the viability of its investment bank.

That said, Royal Bank's directors may well be sending their oppos at Barclays some super-duper Christmas hampers.

RBS board to quit if chancellor vetoes £1.5bn in bonuses

Robert Peston | 15:37 UK time, Wednesday, 2 December 2009


The directors of Royal Bank of Scotland have been given legal advice that they would have to resign if the chancellor of the exchequer were to block them from paying the bonuses they regard as essential to maintain the competitiveness of the group.

RBS logoI have learned that they sought this legal advice after the Chancellor, Alistair Darling, insisted last month that the Treasury will have the "right to consent" to how much Royal Bank pays in bonuses and how it pays those bonuses.

Or to put it another way, the chancellor - as represented by UK Financial Investments, the investment arm of the Treasury - has insisted on a right of veto over bonuses to be paid by Royal Bank.

The scene is therefore set for brinkmanship of a potentially devastating sort for both Royal Bank and the government.

The stakes are so high because of the sheer amount that Royal Bank - currently 70% owned by taxpayers - feels it needs to pay in bonuses to maintain the competitiveness of its investment bank.

I have also learned that Royal Bank has informed Mr Darling that - on the basis of the profits it has generated so far this year - it would expect to pay bonuses 50% greater than last year.

Last year Royal Bank paid £900m of bonuses in its investment bank. So right now it expects to pay up to £1.5bn in bonuses to its investment bankers.

Including bonuses it would want to pay to retail bankers and to employees in the rest of the group, it would intend to pay £2bn in bonuses for its performance in 2009.

Such payments will be hugely contentious, given that Royal Bank of Scotland is only alive as a group thanks to hundreds of billions of pounds of loans, guarantees, insurance and investment provided to it by taxpayers.

However, Royal Bank's directors believe that if they don't pay the "going rate" for bonuses, its top bankers will desert to rivals - thereby destroying a vital part of the business.

In the current year's exceptional conditions, Royal Bank's investment bank has generated some £6bn of profit.

The board believes that up to half the intrinsic value of the bank is in its investment bank. So if the chancellor were to veto bonuses which the directors believe to be essential to preserving that value, they would be under a legal obligation to quit - because they would be prevented from taking actions they perceive to be in the interests of shareholders.

It is understood that Royal Bank's chairman, Sir Philip Hampton, argued to the chancellor that he was playing with fire by insisting on the final say over bonuses.

Mr Darling now has the appalling choice of either approving bonuses that will be described as grotesquely unfair by opposition parties and by many voters, or of sparking a crisis at RBS by prompting the mass resignation of directors.

Mr Darling insisted on the explicit veto over bonuses as a condition of providing £25.5bn of new capital to Royal Bank and insuring £282bn of its loans and investments against losses under the Asset Protection Scheme.

The final decision on bonuses in 2009 will be taken in February.

As a bank, the entire RBS board cannot in practice all quit at the same time. The Financial Services Authority would not allow the bank to be rudderless. But the directors would be able to announce a collective intention to quit, so that replacements could be found in an orderly fashion.

A bubble, or 'stubble', of our own design

Robert Peston | 09:53 UK time, Wednesday, 2 December 2009


Have we reduced the pain caused by the pricking of the mother of all financial bubbles by creating a new financial bubble?

That is increasingly a fear that stalks markets and haunts policymakers.

A row of terraced housesThe unease stems from the following too-good-to-be-true (perhaps) combination:

• a 50% surge in share prices since they hit bottom at the start of the year;
• yields on US and UK sovereign debt that are close to all-time record lows (the lower the yield, the higher the price);
• a consistent rise in house prices (according to the Nationwide, UK house prices are now not much more than 10% below their bubblicious all time highs);
• and a return by bankers to some of the ostensibly reckless lending practices of two years ago.

OK, I know that if you run a small business, and are having difficulty obtaining credit from the bank, you'll think it laughable or insulting that the economy is awash with too-cheap money.

What's happened is that much of the cheap credit and new money created in the US and the UK has leaked - as it was always going to do - into financial speculation (a big hello to all our friends in the investment banks, whose bonus pools are rising faster than the globally warmed seas).

So we may be suffering from a combination of still sluggish growth (or recession if you happen to be British) and bubble, a mixture of stagnation and bubble. Shall we call it a "stubble"?

It's got to have a name, since it represents a bit of a problem for central bankers and finance ministers - who have somehow got to keep the growth going without pumping up the bubble to really dangerous proportions (or may, at some point, have to try to deflate the incipient bubble without tipping us back into recession).

The stubble is non-trivial for businesses and households too. Should they scrimp and save, and batten down the hatches, or borrow to invest as though there's no tomorrow?

The putative stubble is already causing the chief economist of the Bank of England, Spencer Dale, to scratch. This is what he has said this morning, in explaining why he recently voted against creating another £25bn of new money:

"I was also concerned that further substantial injections of liquidity might result in unwarranted increases in some asset prices. I should stress that I do not think there is any strong evidence to suggest than any of the increases in asset prices seen to date are out of line with the improving economic outlook and the desired impact of our asset purchase programme. Rather I was conscious that the current stance of monetary policy - in which Bank Rate is very low and substantial amounts of liquidity are being injected into the economy - increases the likelihood that asset prices may move out of line with their fundamental values and that this could be costly to rectify were it to occur. It is a risk that we need to be alert to."

That nagging fear that markets may again be overheating lay, I think, behind the somewhat hysterical global reaction to Dubai World's decision to suspend payments on $26bn of its debts - in that the direct economic cost of rescheduling the debt is trivial, in a global context, and certainly did not warrant many tens of billions of dollars being wiped off the value of shares.

The FT pointed to another ill augury overnight ("Fears grow about overheated US debt market"): bankers - especially US bankers - appear once again to have had their common sense removed by the prospect of deal fees.

Some bigger indebted companies are again able to borrow with few strings attached: the cov light loan is back.

There has been a revival of Pik toggle notes, which allow borrowers who suffer from cash-flow hiatuses to pay interest as a promise rather than in cash, by increasing the value of the debt they owe (thank you Father Christmas).

And some businesses are even paying fat dividend out of increased debt rather than profits.

Hooray. The holidays are back.

Or perhaps we should take a deep breath and question whether such deals constructed on dubious risk assessments are healthy.

When bankers start behaving like Santa or the fairy godmother, it's normally a sign that the party has been going on too long.

But perhaps more serious is the heated argument taking place between professional investors on whether two of the great economic and financial shifts of this year are bubbles or represent a rock-solid, newly formed, eternal mountain range.

First there's the row over China.

On one side are Goldman Sachs and Anthony Bolton (the guru of Fidelity), arguing that the astonishing revival of Chinese growth is unstoppable - and that you are ninny if you don't buy into it.

But there's also a lot of smart money, especially from hedge funds, betting against China. They fear that the growth is too dependent on an unsustainable Chinese stimulus programme equivalent to 13% of GDP together with an injection into the economy of bank loans equivalent to almost a third of GDP (see George Magnus of UBS in Monday's Times).

And then of course there's that mountain of new public-sector debt which has been created in the US and the UK.

At the moment, that sovereign debt is priced in the market on the basis that it'll be paid back without any difficulty at all (which is what those record low yields mean).

But I have been struck in the past few days by the number of big City banks agonising in public about whether British government debt, in the form of gilt-edged stock, is too expensive.

There have been notes to that hand-wring effect by Morgan Stanley, by Citigroup's Richard Saunders and by UBS's George Magnus (him again).

Their cue has been the recent opinion polls indicating an increased likelihood of a hung parliament as the result of next year's election: they fear that a minority or coalition government would find it almost impossible to take the tough decisions on public spending or taxation that are widely perceived as necessary to restore the health of Britain's public finances.

To put it mildly, it will be fascinating to see whether the price of gilts starts to rise and fall in the coming weeks with changes in the Tory party's lead over Labour.

See also Stephanie Flanders' post Three-way on the MPC.

Shouldn't banks work for us?

Robert Peston | 10:10 UK time, Tuesday, 1 December 2009


According to the distinguished journalist Alice Schroeder, Goldman Sachs bankers are buying handguns "to defend themselves if there is a populist uprising against the bank" (as per a hilarious article published on Bloomberg overnight).

If true, it's one of the more eccentric manifestations of the economic crisis caused - in part - by the excesses of those blessed bankers.

Canary Wharf skyline

Since the UK is officially now the only G20 economy in recession, the UK has a particular interest in fixing the flaws in the financial system.

As it happens, another one of those not-so-popular investment banks, Morgan Stanley, fears the UK may pay one of the steepest amounts when the final bill arrives, because it says that markets are currently under-pricing the risk of a fiscal crisis in the UK next year - which would lead to "some domestic capital flight, severe pound weakness and a sell-off in UK government bonds".

So it's reasonable for most of us to mutter "never again".

And although the path to rehabilitation has been meandering and occasionally bogged down by tedious national jealousies and squabbles, we can be reasonably confident that our banks will emerge a bit better regulated and a bit more intrinsically robust (though it's far too early to pass judgement on whether the reforms will be all they might be).

That said, I suppose I am a little surprised by how little exasperation has been generated by one aspect of our version of capitalism that was found wanting (and how) - which is the non-trivial issue of how our companies are owned.

In a nutshell, the owners of our banks did nothing to prevent them from taking excessive risks - and, the self-justifying bankers moan, some owners actually encouraged them to lend and borrow more than was prudent relative to their capital resources.

What's been the official response?

Well a Treasury-commissioned review by Sir David Walker - which was published last week - recommended that a bit of pressure be applied to investment institutions to either sign up to a fairly undemanding set of governance principles or explain in public why they won't do so.

These precepts include revolutionary ideas such as "institutional investors should monitor their investee companies" (do you think it would be reasonable to ask for my money back, if my pension-fund manager would not commit to doing this?).

Docklands clockAnd overnight, the Financial Reporting Council (FRC) - which will be the steward of the new investors' code - announced plans to amend the existing governance code that for years has applied to the executive and non-executive directors of all listed companies.

These modifications will be seen, I would guess, as mostly sensible.

I particularly like the idea that all boards should every year state in simple plain English a short account of their respective companies' business models: viz how those companies make their wonga over the long term and what the big risks are.

Just possibly, if Royal Bank of Scotland's board had done that a couple of years ago it would perhaps have treated its depositors as its most valued customers rather than taking them hostage, by lending and investing far more than was safe (some 50 times capital resources).

Also, the FRC will probably be applauded for trying to shift the balance of boards' responsibilities from box-ticking and formal compliance to a proper appreciation of their responsibilities as the custodians of the wealth-generating machines that pay for our pensions and generate our tax revenues.

In that context, there may be merit in the FRC's suggestion that each company's chairman, or its whole board, should face re-election every year: the directors should then be under little illusion about who they work for?

Or will they?

Because the chain of ownership - from saver in a pension fund, to pension fund trustee, to investment manager, to non-executive - remains as long, disjointed and dysfunctional as ever.

Arguably we have as yet seen little in the way of actual or proposed reform that would give us confidence that companies will henceforth work rather more assiduously for the millions of us who are their ultimate owners, as contributors to pension funds and other collective investment pools.

Also, in the case of banks, there's a second intrinsic flaw in the ownership structure, which is the potentially devastating asymmetry between the limited liability to losses of a banks' shareholders and the unlimited liability of taxpayers as the rescuers of last resort.

Sir David Walker identified this asymmetry, which encourages banks to take bigger risks than are necessarily healthy for the economy because the liability of the owners is capped.

However it is moot whether he or the authorities more widely have yet done enough to address it.

Here is what should really give us pause for thought: it is our agents, the investment institutions, who have limited liability, but not us, the savers who provide them with the funds to manage; we pick up all the bills, both when the value of the bank shares in our pension funds are wiped out, and when we underwrite the rescue of said banks as taxpayers.

Which is why, some would say, it is particularly hideous that either individually or collectively we have very little direct influence on the behaviour of individual banks or the reconstruction of the banking system.

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