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Archives for May 2010

A coalition housing crash?

Robert Peston | 08:07 UK time, Friday, 28 May 2010


George Osborne is learning the hard way that almost anything a chancellor says about tax can have unintended and potentially serious consequences.

George OsborneI am not referring to the incipient rebellion on the right of his party about the coalition's commitment to equalise the rate of capital gains tax with income tax - thus, for some people on higher earnings, increasing CGT to 40% or even 50%.

I should point out that this spat is a wonderful microcosm of the new politics: economic liberals, such as David Davies and John Redwood, are attacking a Tory chancellor for proposing to throw out an 18% unified CGT rate, which was introduced by a Labour government only a bit over two years ago (and was criticised at the time for being too hard on entrepreneurs).

Mr Davies and Mr Redwood are, in effect, saying that the then Labour Chancellor, Alistair Darling, was a free-market marvel. And that the great Tory tax-reforming chancellor of the 1980s, Nigel Lawson - whose CGT approach Mr Osborne seems to want to emulate - was wrong-headed.

And, by the way, Labour MPs are today more likely to be with Mr Osborne on the need to increase CGT than with his Tory opponents.

How an election changes everything!

But what I am really interested in is the effect on the housing market.

Because it is the uncertainty about what's going to happen that's doing the real damage.

If Mr Osborne had simply implemented the higher tax rate on the day the coalition said that's what it wanted to do, there would probably have been a one-off hit to house prices - as potential buyers of second homes and buy-to-let properties factored into their investment plans the potential increase in future tax they might pay.

But if the uncertainty persists about when the new higher rate will be introduced, the negative effect on house prices could be much greater.

Because for those sitting on significant capital gains above the tax free rate of £10,100, it becomes rational to flog properties pronto - to take advantage of the 18% rate and avoid a tax rate that looks set for most property investors to rise to more than double that.

In a housing market that is still weak, a wave of panicky sales could push down prices in a significant way.

Perhaps that doesn't matter. Certainly, if you are yet to buy your first home and feel priced out of the market, you'll say hooray if prices fall.

But the Treasury is only too aware of the inextricable link between the health of our big banks and conditions in the housing market.

There is a mechanistic link between falling house prices and rising bank losses - because banks are forced by accounting rules to incur losses when the housing collateral underpinning the mortgages they provide drops in value in a substantial way.

And if banks' profits recovery were to be set back by a housing market slump, that would have an effect on their ability to provide credit - which in turn would be a setback to the more general economic recovery.

Which is simply a way of saying that Mr Osborne presumably won't want the uncertainty about what's happening to CGT to persist longer than is strictly necessary.

Pru's receding hopes of AIA victory

Robert Peston | 20:40 UK time, Wednesday, 26 May 2010


It's touch and go whether the Pru is forced by its owners to abandon its £25bn-odd purchase of AIA, the Asian insurer being sold by AIG of the US.

What I am hearing is that three of its big investors, Capital Research Investment, Blackrock and Legal & General, are planning to vote against the deal, in respect of at least some of their respective shareholdings.

Now, I should point out that there's more than a week for them to formally make up their minds.

And these big investors are neither confirming or denying their voting intentions.

But the Pru knows they're less than ecstatic about the proposed takeover and that it has to charm them into submission.

Between them they own more than 20 per cent of the famous British life insurer - though it's highly plausible that a huge manager of various funds like Capital will vote some of its shares against the deal and some for the deal.

So for the sake of argument, let's say that these three shareholders were to collectively vote 16 per cent or so against the takeover - which isn't implausible, given the widespread view (which I'm certainly not endorsing) that the Pru is paying too much to bite off rather more than it can safely chew and digest.

That doesn't on the face of it sound like a disaster for the Pru's management, led by the chief executive Tidjane Thiam, who is travelling the globe trying to woo shareholders on three continents.

But in fact 16 per cent could be enough to kill the deal.

Because the Pru needs a 75 per cent majority of votes cast.

And if there's, say, a 65 per cent voter turnout, 16 per cent would be almost exactly enough to block the takeover.

If that were the outcome, and the Pru were to fail to become the market leading life insurer in one of the most economically vibrant regions of the world, others can judge whether the owners would have performed a public service in squishing dangerous management hubris or would have committed an act of short-termist vandalism on laudable corporate ambition.

One things for sure though: other ambitious British companies would think twice before asking their shareholders to finance empire-building expeditions (which some of you may feel is a good thing, though don't forget that the UK has been selling itself off by the pound to overseas interests for donkeys years).

Europe: Paying for its over-confidence

Robert Peston | 09:57 UK time, Wednesday, 26 May 2010


I've never met Tim Geithner, the US Treasury Secretary, so don't know if he's prone to say "tee hee".

Tim GeithnerBut he must surely feel tempted to say something of the sort to the European finance ministers and central bankers he'll be seeing today and tomorrow.

Because more-or-less all of them were prone to blame the excesses of US financial institutions for the banking crises of 2007 and 2008 - and tended to extol the putative prudence of European banks.

Well it's certainly true that the likes of Lehman, Merrill, Bear Stearns, Citi and AIG were reckless beyond reason during the boom years.

But in the subsequent clear up, they've been forced to raise tanker-loads of new capital - and Congress is well on the way to passing new legislation that would prohibit banks from activities deemed to be more speculative (see my note of Friday, "Obama gets his big bank reforms").

Where is the fault-line in the global banking system today? It runs through the heart of the eurozone.

Big European banks hold less capital relative to their loans and investments than their big US counterparts - which means they are less protected against losses.

And they are significantly more reliant for their funding on volatile and undependable wholesale markets.

So right now, many of Europe's biggest banks look significantly weaker and more vulnerable than America's.

When it comes to frailty, I am largely talking about continental banks: Britain's banks, having taken many of the same ill-judged bets as the Americans, remedied themselves on the same kind of early timetable adopted in the US.

Of course, it wouldn't matter that European banks have relatively less capital and less committed long-term funding if the prospects for these banks was tickety boo.

But you've been asleep this year if you think all is lovely in the European garden.

Just like the American and British banks, European institutions went on a borrowing and lending spree in the boom years.

Their big mistake was to help finance the spending binges by governments in countries such as Greece, Portugal, Spain and Ireland and also to provide the debt that pumped up the Spanish, Irish and British property bubbles.

If, as many now believe, many tens of billions of euros of government and property loans will have to be written off - and I've seen estimates of write-offs running to several hundred billions of euros - then some European banks may have to turn to their governments for support.

I should point out here that data on bank exposures to the overstretched borrowers I've mentioned is neither detailed or comprehensive - so the losses that emerge could turn out to be bigger or smaller than even the wide range of extant guesses.

That said, good regulatory policy is to hope for the best but prepare for the worst.

And what complicates those preparations is that some of the eurozone governments whose banks may get into a spot of bother are already perceived to have borrowed too much.

So if there were to be a second banking crisis, with its epicentre in Europe, there's a question about whether national exchequers would have adequate resources for any necessary bailout.

Which is why, to return to where we came in, Mr Geithner has a legitimate interest in probing those European finance ministers and central bankers on what kind of banking losses they anticipate and can underwrite - because, to rewrite the old markets cliche, if Europe catches a cold, the rest of the world may end up providing some of the medicine.

A European bank tax to pay for dismantling bust banks

Robert Peston | 00:01 UK time, Wednesday, 26 May 2010


The new chancellor of the exchequer and Michel Barnier, the European Union's commissioner for the internal market, are trying to hit it off.

Michel BarnierWhich is why when Mr Barnier announces later today that he believes that all European Union countries should impose a near-identical new tax on banks, the Treasury is likely to point out that George Osborne too is in favour of such a levy: in fact, the coalition has said there may be a case for two new taxes on banks, one on what they borrow and one on their profits.

But there'll be no disguising that Mr Barnier and Mr Osborne could not be further apart on what happens to the proceeds of such a tax.

Mr Osborne's view is that the British government should be free to do what it likes with the revenues.

By contrast Mr Barnier will argue that the wonga should go into national "resolution" funds, whose purpose would be to pay for the orderly dismantling of banks that run into difficulties.

In other words, the proceeds of the tax would be a form of insurance to minimise any future bill for taxpayers, were we to see any kind of repeat of the great banking crisis of 2008 (that suddenly seems a topical anxiety).

Mr Barnier will try to allay Mr Osborne's main concern, which is that banks might be encouraged to redouble their lending and investing follies if they knew that a bailout fund existed to rescue them in the event that their bets were to go pear-shaped.

The commissioner will say that the resolution funds would be used only to provide the kind of temporary finance required to lubricate the break up of big banks - but the money would not be deployed to reduce losses for shareholders and creditors (though retail depositors would remain a protected species).

Red Knights in retreat

Robert Peston | 11:02 UK time, Tuesday, 25 May 2010


The original Red Knight idea, that a bunch of well-heeled Man Utd supporters would club together to buy out the club, looks more-or-less dead.

I've spoken to a number of the potential investors and they all say the same thing: they can't see how to do it without paying more than the club is worth; and they don't want to throw their money away.

Old Trafford football stadium

Why their pessimism?

Well, they'd need to find considerably more than £1bn in equity and debt to provide a return to the Glazers, the not-universally-popular current owners.

Which was always going to be challenging.

Even if the Red Knights had kept Man Utd's £500m of bond finance in place, they would still have had to find perhaps £600m of risk capital.

At, say, a £15m contribution per deep-pocketed fan, it required 40-odd Knights to dig into their respective treasure chests.

That wouldn't have been a doddle even in the balmy (or should that be barmy?) market climate of 2007. In the current volatile conditions of tumbling share prices and concerns about the risks of a lurch back into recession caused by the eurozone's woes, it's harder than breaking through Inter's defence.

So I would say that the prospect of an offer being made to the Glazers by a bunch of "ordinary" fans, who just happen to be worth a bob or two, is as likely as Blackpool winning the Premier League next year.

It's not going to happen.

Does that mean there'll be no takeover bid for Man Utd?

I am not quite saying that.

The Red Knights, advised by Nomura, is scouring the globe for the (you guessed it) inordinately wealthy investor with so much money that he or she can take an improbably long view of when ownership of Man Utd could deliver a profit.

Whether Man Utd's un-monied fans would believe that replacing the Glazers with a more conventional sugar daddy would be progress, I cannot say.

But, of course, with the Glazers having said all along that they don't want to sell, the clever money probably says there won't be a takeover of any kind any time soon.

Update 1500: My colleague David Bond has written a post called Glazers in no rush to pay off Man Utd debt.

How sinister is the Libor rise?

Robert Peston | 00:00 UK time, Tuesday, 25 May 2010


The interest rate at which banks lend to each other in dollars, the famous BBA three-month dollar Libor rate, has been creeping up day after inexorable day since the end of February.

The cumulative impact has been a doubling of that rate during those 90-odd days, to more than 0.5% yesterday - the highest three-month dollar Libor rate for something like 10 months.

What does it all mean?

As you'll probably recall, when Libor rose relative to central banks' official funding rates in an almost unbroken sequence from the summer of 2007 till the autumn of 2008 - when Lehman collapsed - the causes were sinister.

It was the most visible manifestation of perhaps the worst liquidity crisis the world's big banks had ever experienced.

A whole series of wholesale markets in which banks had raised hundreds of billions of dollars closed down. And there was no great pool of cash elsewhere to make up for this great loss of finance - so the interest rates at which banks lent to each soared.

As 2007 turned into 2008, this liquidity crisis transmogrified into a solvency crisis, as the shortage of finance led to sharp falls in the price of assets, especially property and loans to property, which generated huge losses for banks.

The horrible consequence was that a liquidity crisis became a catastrophic solvency crisis: one enormous investment bank, Lehman, went bust, and a series of other financial institutions would have followed Lehman to the graveyard if taxpayers hadn't resuscitated them with unprecedented injections of new capital.

What's more, central banks have - since the Lehman debacle - created unprecedented amounts of new money, and have lent record sums to banks.

That means it's difficult to argue that banks are suffering from a liquidity crunch on anything like the scale of 2007 and 2008.

And if you want evidence that banks really can't be chronically short of cash, just look at how little the European Central Bank has increased its loans to banks over the past 18 days or so: its net funding for banks has risen just 6% or so, which is hardly proof of banks gasping for liquidity.

What's more the take-up of dollar loans by the ECB under swap arrangements with the US Fed has been paltry, even though the Libor prices indicate that the peak of stress for banks is in the dollar funding market.

All a bit odd. Unless you think that what's going on is the reverse of the trends of 2007-8.

It could be that this time a solvency problem is wagging the liquidity dog, rather than a liquidity shortage giving a good shake to the solvency dog.

Or to put it another way, it may be that what's persuading banks' creditors to demand a higher rate for their loans is the expectation that European banks' will suffer big losses on their holdings of assorted eurozone government bonds and their loans to assorted European property markets.

The rising price of Libor may be based on the belief that a possible default by the Greek government on its debts, or a further downward lurch in the value of Spanish property, could generate unsustainably high losses for a number of big European banks.

Or to put it another way, the Libor rise may be saying that the eurozone's fiscal crisis could be the precursor to the demolition of some substantial, thinly capitalised European banks.

Which would be the most worrying interpretation of the Libor rise.

There is however a more benign explanation.

The thrust of anticipated bank reforms - whether they're the Obama reforms or the increases in capital and liquidity ratios to be demanded of banks by the Basel Committee on Banking Supervision - are likely to have the effect of increasing the costs for banks of lending.

And if the costs for banks of lending were to rise, that would mean that banks themselves would have to pay more for their credit, along with the rest of us (ouch). Hey presto, three-month dollar Libor rises in a semi-permanent way.

As it happens, there is one more explanation of the Libor rise: that disunited regulators, central bankers and government heads are largely united by a single reforming ambition, which is to put in place new legal structures for big banks that would allow them to fail without crippling the economy.

Here's the paradox. If big banks can be allowed to fail, if they could no longer be certain that they'd be bailed out by taxpayers in a crisis, the risks of lending to them rise.

So in sanitising the banks, in turning them from weapons of mass destruction into more conventional businesses that can be permitted to go bust, they become less attractive to creditors, who would obviously demand a higher Libor interest rate.

Update 12:05: Three-month dollar Libor has spiked up again, to 0.54%.

Today's bout of investor and creditor nervousness has been triggered by the IMF's analysis of the structural weakness of the Spanish economy and mounting evidence of the fragility of Spain's banks.

There's never been any mystery about the excessive exposure of Spain's banks to a bloated property market. The mystery has been how its banks avoided crippling losses on this exposure - although that increasingly looks like pain postponed rather than avoided.

Or, at least, that's what today's retreat in share prices across Europe is saying, with bank shares falling especially sharply.

And the cost of insuring Spanish government bonds has risen again. Which implies that bond losses could be the double whammy for Spanish banks.

It's all looking a bit unstable again.

Will all business leaders applaud cuts?

Robert Peston | 12:03 UK time, Monday, 24 May 2010


Business leaders have been arguing passionately that the public sector needs to become more efficient. You'll recall that the equivalent of a plane-load of them publicly backed the Tories' general election campaign to make additional savings in public expenditure this year - in order to avoid that national-insurance rise they hate.

George Osborne and David Law hold a press conference in the garden of HM TreasuryWell, it'll be interesting to see how they respond, now that their dreams have been made a reality.

Because a good proportion of the savings announced today will hit them directly.

So, for example, the Treasury has announced £1.15bn of cuts in discretionary spending by Whitehall on items like consultancy and travel.

Who receives the bulk of such largesse? Well, it's private-sector consultants and travel companies.

There'll also be £95m of IT savings - again a squeeze on monies handed over to private-sector contractors.

A further £1.7bn will be saved from delays and cancellations to contracts and projects - which is probably £1.7bn of revenue that won't be received by companies.

On top of all that, there are the reductions in funding for regional development agencies, which could have an effect on financial support received by many thousands of businesses.

In other words, the harsh reality of making government more efficient may not be quite so appealing as the theory to the many business leaders who sell goods and services to the public sector.

As for those business leaders who recognise that there's no gain without pain, they'll only be half-impressed by today's one-off cuts.

They'll see most of today's savings as so-called low-hanging fruit, blindingly obvious examples of eliminating unnecessary expense: what they'll want to see is a cultural revolution, to improve productivity for years to come and create a waste-averse climate in every allegedly cushioned nook and supposedly feather-bedded cranny of the public sector.

Meanwhile, there's another paradox about the effect on jobs of today's cuts.

George Osborne said - and passionately believes - that the cuts in public spending that he announced this morning, and the further and deeper cuts that will be chosen in the autumn, will over time create jobs rather than contribute to intractable long-term rises in unemployment.

The chancellor bases this optimistic view on the assumption that shrinking the public sector, and narrowing the gap between what the government spends and what it receives in taxes, will liberate the private sector - which, he hopes, will create the jobs that are shed by the public sector.

How compelling is this argument?

Well, most would concede that interest rates paid by households and businesses will be lower, in the absence of a collapse in confidence in the government's ability to pay its debts - and that therefore the interest burden on the private sector is irretrievably linked to the perceived financial health of the public sector.

Which means that the private-sector benefits if banks and investors are impressed by the coalition government's determination to shrink the public-sector deficit earlier and faster than the previous Labour government would have done.

But there is an internal contradiction in one of the underlying arguments deployed by the Tories when saying that the state must be shrunk from the 50%-or-so share of GDP that it currently represents: to wit, that the public sector is intrinsically more wasteful, less efficient and less productive than the private sector.

Most research proves that the productivity of public sector is indeed lower than the private sector. But the lower productivity of the public sector means - by definition - that each extra pound of reduced public-sector spending will tend to lead to relatively more jobs lost than are created by each extra pound of income received by the private sector.

To put it another way, the lesser efficiency of the public sector means that it creates more employment than the private sector when expanding, and sheds more when contracting.

Of course, that's not an argument for increasing the size of the public sector relative to the private sector. If that went on indefinitely, we'd all be in the workhouse.

But it does mean that shrinking the public sector can in the short term bring a huge human cost, in jobs lost, and hopes of fulfilling employment dashed.

Which is presumably why the chancellor has not used all his public-sector savings to pay down the national debt. He has also authorised £150m of new spending, to create 50,000 adult apprenticeships, and he is allowing £50m to be spent on the modernisation of further-education colleges.

Shrinking the state may well boost the creation of sustainable jobs in the longer term. But the immediate effect must be to increase unemployment.

Squeeze on industrial intervention and universities

Robert Peston | 09:03 UK time, Monday, 24 May 2010


The two main areas of cuts in the Business Department, to be announced later today, will be universities and industrial intervention.

I am expecting that funding for universities will be cut by around 3%.


And I also hear that there will be deep reductions in the budgets of the Regional Development Agencies for South East England and Eastern England - which may well be seen as the first step on the road to closure of these two agencies, whose aim is to provide support for business that is not available from the private sector.

In addition, a substantial saving is likely to be forced on the UK Strategic Investment Fund, a £750m fund that was the vehicle for French-style industrial intervention by the previous business secretary, Peter Mandelson.

The gross cut in spending at the Business Department will be £900m. But it will also receive £200m of new funding to support apprenticeships, so the net saving will £700 - or just over 3% of its £22bn annual budget.

One area regarded as strategically important for the UK's long term economic prospects, support for science, will be largely protected.

And there will also be protection of funding for further education and adult learning.

In other words, the new business secretary, Vince Cable, will be able to argue that the government is doing what it can to provide relevant vocational skills to those most vulnerable to becoming semi-permanently unemployed at this time of weakness in the British economy.

Also, the Regional Development Agencies in regions where the private sector is smaller and weaker than in the South - notably the North West, North East, Yorkshire and the West Midlands - will not be forced to make the kind of savings being forced on the South East and Eastern RDAs.

As for the squeeze on the UK Strategic Investment Fund, support for green technologies, such as tidal power, will be sustained.

Even so, most university vice chancellors already complain that they have inadequate funding, and will argue that the long-term competitiveness of the British economy will be put at risk by the 3% squeeze - especially since they'll fear that they'll be forced to take even bigger cuts later in the year.

Also, there will be squeals of anguish from those companies deprived of funding by the cuts in industrial intervention.

Obama gets his big bank reforms

Robert Peston | 07:42 UK time, Friday, 21 May 2010


Financial reform in the UK was always going to be conditioned by whatever reforms are enacted in the US.

ObamaAnd as of last night, we now have a clearer - if not yet definitive - view of how Congress is planning to shake up Wall Street.

The important point is that the Senate has - finally - voted for financial reform. Which means that President Obama will get his way, and there will be an overhaul of America's biggest financial institutions more radical than anything we've seen since the 1930s.
But we can't yet be certain of the minutiae of the overhaul, because the Senate's reform package has yet to be reconciled with the House of Representatives.
Here, in general terms, is what is likely to happen:

(1) Most of the $600 trillion derivatives market will be forced through third-party clearing houses, to increase oversight of the deals and ensure participants in the deals put up sufficient margin or security against the risk of losses. As I've mentioned before, this will significantly reduce the profitability of derivatives trading for banks, because it will lessen their ability to blind gullible investors with the wizardry of their science.

(2) Banks may be banned from proprietary trading or speculating for their own account.

(3) An important part of banks' derivatives business, their swaps desks - which include the business of insuring loans through credit default swaps - may be walled off, or forcibly separated.

(4) There'll be a powerful new consumer protection agency.

(5) There'll be new powers for the authorities to seize control of large systemically important institutions that appear to be running into difficulties.

(6) There'll be new powers for the authorities to break up troubled systemically important institutions in a supposedly orderly way.

(7) There'll be new multi-authority oversight of the risks in the financial system.

(8) In general, the Federal Reserve will emerge as the regulatory super-power, though the precise scope of its remit remains to be defined.
What does it all mean?

In theory, banks will be taking fewer risks - and they will certainly be less profitable.
There will be a particular challenge to the business model of Goldman Sachs, which generates more profit - in a proportionate sense - from proprietary trading and derivatives than most of its competitors.

The reforms would have direct implications for Barclays, owner of defunct Lehmans' US operations.

And there will be indirect implications for all big British banks, because where America leads in financial reform has a significant influence on the room for regulatory manoeuvre of the British government.

Finally, there is a knock-on to conditions in global financial markets, especially stock markets, in the coming weeks.

Investors will fear that US banks forced by Congress to retrench and narrow their scope will be less generous with the provision of credit and liquidity, which could dampen the economic recovery.

There's always a bill, a price, for necessary financial reform. Calibrating that price, in respect of timing and size, is the tricky part.

Will Vince Cable become chairman of the banks?

Robert Peston | 12:44 UK time, Thursday, 20 May 2010


The coalition's programme for government will not please all businesses and business people.

cable_coalition226.jpgThere is a surprising amount of detailed policy to promote equality, for example, which will give the willies to some of the more traditional Tory-supporting corporate grandees.

So, for example, there's a pledge to promote gender equality on the boards of listed companies.

That said, there's conspicuous gender inequality on the board of UK plc, otherwise known as the cabinet. And if the target is to match the balance between the sexes in Mr Cameron's team - well, most big companies won't be sweating.

As for the banks in which taxpayers own huge stakes, Royal Bank of Scotland and Lloyds, they may be somewhat alarmed by the remarks this morning of Vince Cable, the business secretary, that they should become instruments of the state.

In particular, he wants to rip up their agreements with the previous government to provide a specific amount of gross lending to business and to replace those agreements with new targets for net lending.

This may sound a technical issue of little importance, but it matters.

As I've pointed out here on many occasions, any bank can take money out of the economy while increasing gross lending, so long as repayment of existing loans exceeds new lending.

It's therefore much more stretching and demanding for a bank to be obliged to increase net lending.

Banks however would argue that it would be bonkers to oblige them to increase net lending, because they would be under pressure to provide credit to those who don't deserve it.

And they would also make the point that what got the UK into its current economic mess is that banks lent far too much to households, businesses and other banks: forcing them to repeat the mistake would seem a little weird.

To which Vince Cable would reply that he only wants to make sure that small and medium-size businesses can tap into the credit they need at this delicate stage of the economic recovery - and that there's plenty of evidence that these foot-soldiers in the battle to rebuild the economy are being starved of vital financial provisions.

It's a finely balanced argument. And the government may yet opt for providing a more generous scheme of taxpayer-backed bank loans for small businesses, in preference to coercing Lloyds and Royal Bank to do more.

What I would point out, however, is that if Mr Cable were to opt for new net lending targets for the two semi-nationalised banks, the argument could become a fraught legal one.

Because Lloyds's and Royal Banks' gross-lending agreements are written into lengthy binding contracts relating to support they've received from taxpayers - and it may not be quick, cheap or easy to re-write these agreements.

Also, as I've pointed out in respect of a previous scrap between banks and ministers over bonus payments, the directors of the banks would probably have to resign if the government forced them to extend credit in a way that they felt was uncommercial and was contrary to the interests of all their shareholders.

Mr Cable could find himself having to chair the banks' boards as the price of bossing them around.

So is there no joy in the government's shared agenda for the private sector? Well, there is a commitment to create the "most competitive corporate tax regime in the G20" - though no detail on how that will be judged - and a vow that any new proposed regulations will only be introduced if first other bits of red tape of greater bothersome effect are first abolished.

Also, there looked to me to be a reason for non-doms to crack open the bubbly.

Because the Tories' election manifesto had pledged that these (mainly) well-heeled individuals who live and work here, but pay tax (if at all) elsewhere, would pay a new flat-rate levy - and the Lib Dems had pledged to phase out the tax advantages for non-doms altogether.

So what does the coalition's to-do list say? Only that the government "will review the taxation of non-domiciled individuals".


My sources in the coalition insist that this review should strike fear into the heart of the tax-avoiding non-dom community, that (really, truly) it is not an example of a review being a substituted for action.

Time will tell. But if past reviews of non-doms' taxation is anything to go by, the plutocrats don't need to be booking their flights to Switzerland quite yet.

Germany: Right and wrong on naked shorts

Robert Peston | 09:20 UK time, Thursday, 20 May 2010


Those who criticise the German government for trying to restrict the use of naked shorts and credit default swaps (CDS) are - on the whole - concerned about the when and the how, rather than the whether.

Or to put it another way, there are strong arguments for restricting the use of credit default swaps, or insurance policies for loans, in that their use exploded well beyond what could seen as sensible protection against loans going bad.

At their peak a couple of years ago, there were $60 trillion of extant credit default swaps, insuring loans with a value of around $6tn. This was the equivalent of taking out 10 buildings insurance policies on a single house, or 10 life policies on one individual.

The point is that $6tn of credit default swaps would have provided appropriate cover for the risk that the loans might go bad.

And just as you might feel a bit anxious if your neighbours took out nine insurance policies that would enrich them in the event that your house burns down or you pop your clogs, it is reasonable to fear that the other $54tn of CDS contracts were not all taken out with the purest of motives.

As I've pointed out before, many of these CDS contracts were a way of speculating in the fortunes of a business or a government, without the regulatory hassle of trading on a transparent, well-scrutinised, regulated exchange.

If a hedge fund or speculator thought that a company, government or specially created investment product, such as a collateralised debt obligation, were going to the dogs, a CDS was (and is) a way of making a killing from their respective woes.

And, perhaps best of all, that killing could be made well away from the prying eyes of media or regulators: it was the last frontier of a financial wild west.

None of which would have mattered all that much if - to coin a phrase - the cowboys in this financial Wild West had only hurt their own.

The problem is that many of the world's biggest financial institutions, giant insurers such as AIG and assorted banks, couldn't resist the gold rush - but found themselves on the wrong side of these CDS deals.

So when the speculators made profits, the insurers and banks made enormous losses. And the tab for these losses was eventually picked up by taxpayers, because (as you'll be tired of hearing by now) the damage to all our prospects would have been unbearable if we'd allowed these cornerstones of the economy to crumble.

All of which is a meandering explanation for why there is a powerful argument for reforming the CDS market.

As you'll deduce, there is a strong case for banning naked CDSes, or the use of credit default swaps by those who don't actually own any of the relevant debt being insured.

There are also good reasons for forcing all CDS trades through transparent, regulated exchanges and clearing houses, to provide some kind of verification that they're not being used for insider trading, and to ensure that counterparties to deals put up appropriate "margin" or cash when prices swing as proof that they have the wherewithal to honour the contracts.

Here's the thing however.

It's quite possible to be the world's harshest critic of the explosive growth of credit default swaps and still take the view that the German government took leave of its senses on Tuesday night when it imposed a unilateral ban on their use in respect of the debt of eurozone governments.

How so?

Well, in the world as it is - as opposed to the world as we might like it to be - the financial institutions who use credit default swaps provide vital loans to eurozone governments and businesses.

And if they're told that, at a stroke, they can't use those credit default swaps, well then investment climate for them in the eurozone is perceived to become harsher - and it becomes rational for them to seek to put their cash elsewhere.

Christine LegardeThe French finance minister, Christine Lagarde, has grasped the risk: she said yesterday that she was concerned that the German prohibition, if followed by other governments, would reduce liquidity in the eurozone government bond market - which, in theory, means that the price of those bonds would fall and would push up the cost of funds for eurozone governments.

There's a time and a place for radical reform of financial markets. The place is probably the world as a whole, and not just one part of it - because unilateral national initiatives may either be ineffectual or may create dangerous distortions in the allocation of capital around the world.

And the time is probably when there's evidence that fiscal deficits in Europe are on a pronounced downward trend and economic recovery is entrenched.

The worst time to alienate investors and banks by restricting how they invest is when they are anxious about the strains within the eurozone and can simply shift their money to other places where they feel more welcome.

Eurozone may not be helped by naked shorts ban

Robert Peston | 08:45 UK time, Wednesday, 19 May 2010


Bafin, the German financial regulator, was on the blower last night to other European regulators, trying to persuade them to participate in its attempt to ban purely speculative bets by investors that eurozone governments will have growing difficulties paying their debts and that the woes of banks will also worsen.

Euro notes and coinsUnless other regulators do the same - and there were signs last night that some important ones may not - it's difficult to see how the German initiative can have much impact, given that the trading of government bonds and bank shares is a global business.

Or to put it another way, very few of the investors doing the short-selling that Bafin wants to prohibit are German and almost all the relevant securities are traded in financial markets other than Germany's.

Which is not to say that it won't have any effect at all, though not necessarily of the sort that Bafin or the German government desires.

Investors see it as a fairly desperate attempt to ease strains in eurozone markets and fear that it shows that eurozone governments are running out of policy options to hold the eurozone together - so they have sold the euro, which has fallen to its lowest level against the dollar for four years.

What Bafin is trying to do is reduce the volatility of financial markets and the instability of the financial system. But it could have the opposite effect, even if Bafin secures agreement on a Europe-wide prohibition - because the distinction that Bafin wishes to draw between naked short selling, which it hates, and hedging, which it thinks is acceptable, is not as clear cut as it appears to believe.

The German ban is three-pronged: on short sales of eurozone government debt unless the investor has first borrowed the stock; on the use of credit derivatives to bet on a fall in the value of the debt of a eurozone government, unless the investor owns some of the relevant debt; and on short sales of the shares of German banks and insurers, unless the investor has first borrowed the shares.

Bafin sees this as an attempt to put a stop to what it would see as mischievous bets by investors that the financial difficulties of the likes of Greece and Portugal will worsen.

It thinks that such bets are what force down the price of Greek and Portuguese government bonds, which then spook investors, and make it much more difficult and expensive for the likes of the Greek and Portuguese governments to borrow vital new money.

That may be so.

But there's an alternative narrative about the use of naked shorts and credit default swaps which would show them to be less malign than Bafin would believe and which would imply that their prohibition could increase the vulnerability of financially overstretched eurozone governments.

Many investors use credit default swaps taken out on the debt of one government to hedge exposure to some other kind of investment in the same country or to the debt of another eurozone government, inter alia.

So banning the use of credit derivatives and naked short-sales for eurozone government debt could prompt some investors to liquidate those "long" investments and lessen investors' appetite for investing in the eurozone in general.

Which, at the moment when eurozone governments and banks need all the credit they can lay their hands on, would not be the result favoured by the German government.

Update, 11:40: I now have clarification of the scope of the Bafin ban.

It applies only to trading by the financial firms it regulates - and only to naked shorts and CDS's in those eurozone government bonds listed in Germany and also to German banks/insurers listed there.

So its direct impact on speculation in those securities will be only limited, as I pointed out earlier.

Here's the proof of its toothlessness: Deutsche Bank's London branch has agreed to abide by the ban (though I'm unclear that it was obliged to do so), whereas the London operations of Goldman Sachs and Morgan Stanley can continue shorting these products to their heart's content.

As to whether other countries might follow Germany's lead, I am hearing that Austria and Belgium may well impose similar bans - but there's no sign of the larger economies doing so.

So what's motivating the Germans?

Well the view from the London markets is that it's all about persuading German voters and politicians that supposedly horrid speculators are being knee-capped, to allay their concerns that German participation in the great trillion dollar bailout of the eurozone isn't throwing good money after bad.

And never mind that some of these horrid speculators might have funds to invest in the eurozone, and may now take their money to places where they're more welcome.

Will Osborne cut and simplify corporation tax?

Robert Peston | 00:00 UK time, Wednesday, 19 May 2010


Tonight, the new chancellor has his first outing in front of what you might call middle business, as opposed to Middle England, when he addresses the CBI's annual dinner.

George OsborneGeorge Osborne's theme, for a change, won't be cuts, but growth - or how to engender the kind of renaissance in Britain's private sector that would generate the tax revenues and jobs that can help us out of our malaise.

So what's his cunning plan?

Well, when he thought and hoped the Tories would be governing alone, his flagship policy on all of this was to simplify the tax system for companies and reduce the headline rates of corporation tax - from 28p in the pound to 25p for larger businesses and from 21p to 20p for small companies.

The costs of reducing these taxes was to be financed, according to the Tories' manifesto, by "reducing complex reliefs and allowances".

And the Tories told me that they would do all this in the emergency budget they've consistently said would take place within 50 days of a general election.

Readers of this column will know that I've highlighted on a number of occasions that in respect of this particular tax policy, there has been a significant and unusual ideological divide between the Tories and Labour: Osborne wanted to streamline the tax system for companies, in contrast to the Treasury of Gordon Brown and Alistair Darling, whose philosophy was to target tax reliefs and fiscal aid at sectors thought to be particularly deserving.

So I was slightly surprised that there was no mention of any of these tax reforms in the agreement between the Conservatives and the Lib Dems that underpins their governing alliance.

Did that mean Osborne had ditched these ambitions to simplify that are redolent of his Conservative predecessor at the Treasury, Nigel Lawson?

I'm told not, by those close to Osborne.

On the other hand, his new Lib Dem colleagues have been pointing out that Gordon Brown's jibe - that the policy amounts to a tax cut for banks and a tax increase for manufacturers - is not a total canard.

The fiscal reality is that manufacturers tend to be big beneficiaries of allowances for capital spending of the sort that Osborne would reduce - and banks have less opportunity to reduce their tax payments by exploiting such reliefs.

Also most biggish businesses, in my experience, rather like the existing tax credits for research and development, and are unenthusiastic about the Tory manifesto promise to redirect them at "hi-tech companies, small businesses and new start-ups".

It's true therefore that a policy of reducing the various business tax allowances would have the effect of pushing up the tax burden on the kind of companies that make and export things deemed vital to the UK's economic future, even if the headline rate of tax were reduced - whereas the tax burden on banks would tend to be reduced in these circumstances.

That's why the Lib Dems themselves never went further than flirting with the idea of simplifying the corporate tax system two or three years ago: they couldn't see how to implement such a policy without penalising too many businesses necessary for the UK's ability to pay its way in the world.

What will Mr Osborne actually do, now that the levers are in his hands?

I can't see him abandoning the commitment to cut and simplify corporation tax. To do so would be a humiliating U-Turn on a genuinely flagship policy.

On the other hand, I would be staggered if he didn't do something to ease the transitional pain of those companies that invest a great deal, and therefore benefit most from the tax break on capital spending.

Somehow it doesn't seem plausible that Osborne would stand up tonight in a room full of boozed-up manufacturers and tell them that their subscription price for operating in the UK is about to rise sharply.

RBS and HBOS: Questions of competence, not corruption

Robert Peston | 15:30 UK time, Tuesday, 18 May 2010


Johnny Cameron, the cove who ran Royal Bank of Scotland's investment banking division at the time the bank went to the very brink of collapse, has agreed with the City watchdog that he won't ever again work full time in a senior position in the financial services industry.

RBS logoHmmm.

You might find that story about as surprising as "starving, rabid dog in hot climate bites sweaty fat man".

Or to put it another way, after Royal Bank was bailed out to the tune of around £50bn by taxpayers, it would be slightly odd if any of those in senior executive or non-executive positions at RBS back then were deemed suitable stewards of financial businesses.

In fact what some may wonder is why - some 18 months after the meltdown at RBS - Mr Cameron is so far the only former director of that bank to be the object of a formal restriction on where and how he can work.

It's also worth noting that Cameron jumped before he was pushed: he agreed to be disbarred (so to speak). But he retains the right to act as a part-time advisor to City firms (which, since his very public humiliation, is all he wanted to do, in any case).

Here's perhaps the most significant part of the FSA's statement about Mr Cameron:

"The FSA has not made any findings of regulatory breach against Cameron and he has not made any admissions".

Or to put it another way, the FSA questions his competence to run a bank, but doesn't think he broke any of its rules.

What that implies is that it's quite possible to be on the bridge of one the world's great banks, which is part of the UK's economic infrastructure, as it ploughs into a humungous iceberg, while following the FSA's rulebook and the law.

Some, I suppose, may wonder whether the rules and the law are quite what they should be.

What also follows?

Well, the FSA continues to investigate the events leading to the disasters at RBS and at HBOS.

In RBS's case, the focus is on its reckless acquisition of the poisonous rump of the Dutch bank ABN Amro, which made RBS too dependent on unreliable short-term funding in the wholesale money markets and also imported several tankers of loss-making loans and investments on to its overstretched balance sheet.

At HBOS, the FSA is looking at how the bank lent so many tens of billions of pounds to companies - especially property ones - that were acutely vulnerable to any economic slowdown.

Both probes have been going on for well over a year. So it's reasonable to conclude that if the FSA had found evidence of fraud or serious malpractice, we would have known by now - such is the propensity of these things to leak.

What that means is that if the FSA finds that the banks and their directors did anything untoward, the verdicts are likely to be about their competence and diligence, not their probity.

Which some might see as something of a great escape for bankers who many would hold responsible for the biggest raid on taxpayers' wealth in British history.

Pru pays £850m in City fees and expenses

Robert Peston | 09:37 UK time, Tuesday, 18 May 2010


I'd not met Tidjane Thiam, the chief executive of the Prudential, till I interviewed him yesterday. And unlike many business leaders I encounter, for whom the expression charmless nerk was probably invented, it's not hard to see how he has reached the top: he's persuasive, amusing and self-deprecating.

Tidjane ThiamOn the issue of the moment, whether the Pru's investors should approve his ambitious plan to buy AIA for almost £25bn, he is an impressive salesman.

As if you didn't know, if you want serious long-term growth, there's no better place to go shopping for business assets than Asia. And as for the putative treasure sought by the Pru, AIA, it's at what Thiam describes as an "inflexion point".

Which means that AIA's profits are soaring, he says, because of a combination of recovery in the Asian economy and the great sense of liberation of its local management that they're soon to be freed from the stigma of being owned by AIG, the US insurer that crashed spectacularly in late 2008.

So those valuation ratios, based on historic financial information, which show that AIA is a very pricey purchase, well he would say they're misleading: he believes that the momentum behind AIA's progress, and the potential to generate incremental income from combining AIA with the Pru's existing Asian operations, mean that this deal could look very cheap indeed, by 2013 or so.

He also insists that he and his colleagues have an intimate knowledge of AIA's main businesses in 10 different countries, because for years they've modelled their own Asian operation on AIA's. So he insists there's only a small risk that they'll find poison, rather than gold, in AIA's coffers.

Here's my problem: I've heard it all before (not from Thiam of course), from bosses of big companies explaining why making a giant acquisition is oh so right.

It's really not that long ago, for example, that Sir Fred Goodwin of Royal Bank of Scotland and John Varley of Barclays were whispering in my shell-like that the Dutch bank ABN was a corporate dream come true, a buying opportunity that was too good to miss. But as taxpayers - who have picked up a hefty bill for cleaning the mess up - have found out, the deal that was ultimately done, which included RBS buying the rump of ABN, could not have turned out any worse.

So it's not altogether surprising that some Pru shareholders are far from being sure that they want to pay up for those fat birds that Thiam has spied in the Asian bush. Perhaps it is lack of ambition and imagination on their part, but these investors quite like the British and American birds-in-the-hand that the Pru already holds, even if their plumage isn't quite so vibrant.

And here's a statistic which investors need to mull over: according to a 936-page prospectus published this morning, the Pru would pay out a staggering £850m in fees and other expenses to bankers, brokers, lawyers, accountants and fund managers in connection with the takeover and the rights issue to raise £14.5bn.

That's an astonishing amount of revenue for the City of London. And if you want to see how important that £850m is to the prospects of financial firms, it would be enough to pay the salaries for a year of 4,250 bankers (on the assumption they're each paid £200,000) or well over 30,000 British employees on average earnings.

More-or-less every big City bank has been offered a piece of this particularly luscious, deep-filled pie. Which means that all of them are in effect on the Pru's payroll, thus preventing them from publishing objective research for investors on whether this deal is sound or not.

To put it another way, much of the City has a vested interest in seeing the Pru complete this massive takeover. And there would be even more fees for bankers to come, if Thiam were to follow up the purchase of AIA with the sale of the Pru's operations in the UK and the US - which he told me he would sell if the price were right.

So here's the question, as old as the City itself (well almost): is the City there to facilitate wealth creation for the benefit of those who provide it with finance, which is actually you and me through our pension savings and deposits; or are the judgements of those who work there as bankers and advisors flawed by the opportunity to skim off rents for their own enrichment?

Those who own the Pru will be asking themselves a version of that question as they decide in the coming weeks whether to back or block Thiam.

GLG sells as Pru buys

Robert Peston | 09:16 UK time, Monday, 17 May 2010


No one can accuse the Prudential's senior directors of being averse to risk - although, to state the obvious, most of the risk doesn't actually fall on them but sits with the Pru's owners.

Prudential logoAgainst the backdrop of frayed investors' nerves - with stock prices dropping again in Asia - the Pru is attempting to raise a colossal sum of new money from its shareholders, some £14.5bn, to finance the acquisition for almost £25bn of AIA group, the Asian insurer being sold by AIG of the US.

The fund-raising is 12 days later than planned - because of an order from the UK watchdog, the Financial Services Authority (FSA), that the Pru should raise more capital as a buffer against potential losses, in view of what it calls the risks "associated with current market circumstances and the potential risks associated with the acquisition".

This new capital takes the form of up to £5.1bn of new hybrid securities - or low-quality, subordinated debt that would only just be in front of equity in the queue for repayment in the event that the Pru were to run into serious difficulties.

In order to win approval from the FSA, the Pru has also had to agree to intensive, continuous, global supervision by the British watchdog and a new structure to prevent contamination of the entire company should one part become poisoned.

The Pru is selling the new shares in this rights issue at 104p each - a discount of 81% to the Pru's closing price on Friday.

So there would have to be financial Armageddon, and an almost unthinkable collapse in the Pru's share price, for existing Pru shareholders to refuse to buy the new shares.

But it won't be plain sailing for the Pru's management.

Although the Pru has released new figures this morning showing that the AIA is performing better than it thought only a few weeks ago, and it believes that AIA's post-tax profit from new business can increase by more than $1bn in three years, few would argue that it is buying AIA at a bargain price: the ratio of purchase price to so-called embedded value is 161%, a premium to recent valuations of other Asian insurers.

Which is why some Pru shareholders fear that it is taking an excessive gamble in buying AIA.

It's not that they dissent from the notion that growth prospects in Asia are vastly superior to those of the US and UK.

But they would argue that what they opted for when they bought into the Pru was a diversified international business, with operations in the UK and US that may be slightly staid but have the virtue that they generate cash. What they didn't choose to own was a giant, cash-consuming Asian operation, which is what the Pru has chosen to become.

These shareholders would argue that they could invest directly in Asia, without the need for the Pru to take on all the management risks of more than doubling in size and multiplying the number of businesses to control.

Here's the interesting contrast. GLG, one of the smartest hedge-fund investors in London, announced today that it is selling out to Man Group, while the Prudential - whose investment returns aren't in the same ball park as GLG's - is making a record-breaking purchase.

GLG's owners may be taking Man stock (they are not liquidating) but they presumably believe the valuation of their investment management business isn't going to get any better.

So, in what the FSA euphemistically calls "current market circumstances", is this the moment to be a buyer or a seller?

The Pru's management still has its work cut out to persuade its owners to back the AIA takeover. That deal could yet fall apart.

Why are the Germans bashing hedge funds?

Robert Peston | 18:00 UK time, Friday, 14 May 2010


First week in power, and already the Cameron/Clegg government faces defeat in negotiations on new European Union rules for hedge funds.

But this is not a case of start as you mean to go on: it is not early evidence that the new administration will be more isolated in Europe than the previous one.

Had Labour been victorious in the general election, it would also have been mugged in the European Council.

Because the British position on hedge funds, for both Labour and the Con-Libs, is to defend what they see as relatively successful British businesses (albeit businesses where the legal domicile is usually the Cayman Islands); whereas a majority of other EU members, and notably the Germans, want to bash the hedgies.

As I've mentioned many times here, there is a widespread view on the continent that hedge funds somehow caused the credit crunch and financial crisis of 2008.

Which is an eccentric view, because even if it's challenging to characterise hedge funds as socially useful, the evidence is conclusive that when apportioning blame for the global financial debacle, hedgies were barely at the scene of the crime compared with many big banks (see my note Hedge funds as heroes for an assessment of what bad stuff can be laid at the door of hedge funds).

Also, many continental politicians and journos seem to believe that the current stresses and strains in the eurozone have been magnified by the supposedly heinous dumping and short-selling of government bonds by hedge funds.

But the biggest sellers of eurozone government bonds have been the trading desks of banks. And as those banks were bailed out by taxpayers - whereas hedge funds weren't - it is slightly odd that the fury of eurozone governments isn't directed against the giant banking groups, rather than the hedgies.

As a friend points out, the behaviour of some banks in trashing the bonds of over-indebted countries is particularly churlish, in that much of those frail countries' debts stems from the costs of bailing out the same banks: that'll teach us to rescue them.

As germanely, the proposed restrictions on hedge funds will have no effect on what they can buy or sell: a hedge fund based in New York will still be able to bet against Portuguese debt if it so chooses; the constraints would be about the kind of risks that a hedge fund that is based in Europe and raises money in Europe can take, not about the scope of trading by hedge funds as a global group of investors.

But even if it may not be wholly rational to beat up the hedgies, it's clear that a majority of EU members are minded to do just that. The new Chancellor, George Osborne, may make a brief show of being the hedgies' human shield at next week's ecofin meeting of European finance ministers, but he knows the votes are on the other side.

So on the reasonable assumption that the UK has lost, what's at stake?

Well a bit.

If hedge funds operating in London want to be able to raise money throughout Europe, they'll have to be domiciled in Europe, they'll have to be more transparent, they'll be subject to new limits on how much they can borrow, and they'll have to place their assets in safekeeping with a single so-called depository.

These are not trivial requirements and nor are they conspicuously benign.

The requirement for a single depository looks particularly weird, because it will concentrate the damage when a hedge fund collapses rather than disperse it.

If for example such a system had been operating globally two years ago, when hedge funds started to worry that their assets weren't safe at Lehman Bros, the run on Lehman by its hedge fund clients would have been even more devastating.

Also rules restricting the leverage or borrowing of hedge funds may not be completely bonkers. But the current draft of the leverage rules is vague - although it's already clear that they would be far more onerous than the leverage rules that apply to a class of institution far more important to our prosperity, the banks.

That said, London-based hedge funds may be able to escape the full impact of these new restrictions, because very few of them are - in a legal sense - British or European institutions; as I mentioned, most of them are domiciled in the Cayman Islands, to shelter the tax of their investors.

So if they insist on retaining Cayman as their official home, they may benefit from a waiver that would enable them to raise money via so-called private placements from professional investors in the UK, though not in the rest of Europe.

In other words, the choice facing London based hedge funds, broadly, is to circumscribe where they raise their money or be subject to much more red tape.

Which sounds more like an annoyance for them, rather than a disaster - and makes you wonder why Germany, France and the others are bothering.

What Volcker thinks

Robert Peston | 09:11 UK time, Friday, 14 May 2010


Paul Volcker has an almost mythical status as the last unambiguously successful chairman of the US Federal Reserve, wise counsellor to President Obama and the man who supposedly knows how to fix the global financial system.

Robert Peston and Paul VolckerHe's even lent his name to perhaps the boldest of Obama's proposed financial reforms, the Volcker Rule - which, if implemented, would ban licensed banks that receive taxpayer protection from engaging in proprietary trading, or significant trading for their own account (as opposed to working for their clients).

He was in town yesterday, giving a speech at the annual Wincott Awards for financial journalists. And I managed, in an impertinent way, to perform a journalist's arrest on Mr Volcker for two minutes: what he said into my microphone can be heard in a piece I put together for the Today Programme.

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I also had a longer chat with him, armed only with a notebook, and he made fascinating points in his off-the-cuff speech.

Here is what he believes can and will be done to mend broken finance, and where he sees the big looming risks.

1) He has no doubt that Congress will pass the Volcker rule.

2) He defines the Volcker rule in a simple way, which is that banks should use their capital only to serve the interests of their clients, rather than trading to generate speculative profits for their owners. He believes that if boards of banks are aware that's the spirit of a new law, they will impose significant restrictions on the activities of their executives.

3) He is not advocating a return to Glass Steagall, or a stipulation that retail banks should be wholly prohibited from engaging in investment banking, such as underwriting securities. He for one probably wouldn't say hooray if the new British government's independent banking commission came up with a scheme for complete separation of retail and investment banking (which is what it is apparently being mandated to find, based on the formulation in the Tory-LibDem agreement).

4) The Volcker rule would have profound implications for a relatively small number of US banks, perhaps four or five. The most profoundly affected would be Goldman Sachs, which might feel obliged to give up its banking licence, in order to continue trading for its own account on the scale it has been doing.

5) His tone was pretty downbeat about the likelihood that the regulators and central bankers of the Basel Committee on Banking Supervision would any time soon come up with proposals to reform capital and liquidity requirements to significantly improve the robustness of the banking system. Which is why he is a passionate advocate of his own structural reforms.

6) Because there may be some element of trading by investment banks that can't be formally prohibited, he believes there may be a role for massively increased capital requirements on residual trading activities by banks (which is what Lord Turner advocates).

7) America's financial sector became far too big, relative to the US economy.

8) Much financial innovation was designed to extract rent (often in the form of premia paid by gullible investors) rather than making a contribution to the growth potential of the economy.

9) He is not in favour of Senator Blanche Lincoln's proposals which in effect would have banned involvement in derivatives by banks with access to liquidity support from the US Federal Reserve (I am told her clause in the financial reform bill being debated in Senate is likely to be voted down next week).

10) Derivatives need to be made safe, in Volcker's view, by forcing more-or-less all derivative trading through central clearing houses and regulated exchanges. This would mean that those exposed to derivative transactions would have to post more collateral when prices move. And it would make the transactions more transparent and more open to scrutiny. Such reforms would also make these deals much less profitable for investment banks, by reducing their ability to extract rent from the gullible, which is why they're hated by many bankers.

11) When I asked him whether he favoured new taxes on banks, of the sort proposed by the International Monetary Fund and the new British government, he said that was not something he has been advocating.

12) The financial stresses on the eurozone are the big concern of the moment (as we know). He implied - though didn't quite say - that he couldn't see how the eurozone could survive without further political integration that would legitimise necessary coordination of member states' tax and spending policies. If he's right, the pro-European Lib Dems in the new government, including Mr Clegg, might I suppose become concerned that the UK would be an outcast from a more integrated EU central core - which could test the unity of the new coalition.

13) He said that we should not kid ourselves that it's business-as-usual again in international finance. Banks and the financial system remain on life support provided by taxpayers. He gave the example of the US mortgage market: mortgages securitised into bonds are the biggest part of the biggest capital market in the world (the US bond market); and 90% of all mortgages are - through the mortgage-backed bond market - in effect granted or bought by US government agencies. Which is not, in any sense, free-market capitalism.

BP leak costs soar

Robert Peston | 08:39 UK time, Thursday, 13 May 2010


There's been a dramatic increase in the costs for BP of its efforts to contain the oil spewing into the Gulf of Mexico from a damaged deep-sea well.

BP clean-upBP this morning estimated the cost to date as $450m, up from a $350m estimate published on Monday.

That implies that the daily costs are $33m, compared with daily costs of $18m just three days ago and an initial daily cost rate of $6m calculated by BP on April 30 - which was some eight days after the explosion that killed 11 rig workers and caused what is turning into a significant environmental disaster.

To put that into context, that's considerably more, on a per-day basis, than the British government spends in aggregate on the energy, environment and culture departments plus the Foreign Office - and it's only a bit less than the entire Home Office budget.

The scale of the relief effort is therefore equivalent in financial and resource terms to running quite a big chunk of the British public sector.

How on earth can that be?

Well the relief effort has involved the deployment of 13,000 personnel from BP, other businesses and US government agencies and the use of 530 boats, to skim and direct the oil.

There has also been 120 dispersant-spraying flight and 1.2m feet of boom has been floated to prevent the oil reaching the coast.

And then, of course, there's the considerable expense of the efforts 5,000 feet below sea level and using robotic devices to plumb and stop the leak - which has so far proved unsuccessful and which BP is pursuing without being able to provide any kind of guidance about when or even whether there will be a reduction in the 5,000 barrels per day gushing into the water.

Huge as these costs are, BP can afford them - they represent about 13% less on a per-day basis than BP generated in profit last year.

But they don't take account of future compensation claims and possible future fines.

So it's not completely inconceivable that the final financial bill for BP would wipe out an entire year's profit - which if you live and work on the imperilled Gulf coast you probably regard as a comparatively lenient form of financial natural justice.

Lib Dem voice is loud on banks and tax

Robert Peston | 07:56 UK time, Wednesday, 12 May 2010


The Tories may have won the most votes and have secured the most MPs, but some in the City may well see the Tory-Lib Dem coalition as something of what they would call a reverse takeover by the Lib Dems.

Vince CableBecause much of is emerging as the new government's policies towards the banks and on taxation bears the influence of Vince Cable, the Lib Dem's shadow chancellor.

There'll be an independent commission to look at whether the big so-called universal banks, such as Barclays and Royal Bank of Scotland, should be broken up, so that the more speculative investment banking activities would be formally hived off.

This is consistent with the Tories' manifesto position, but Mr Cable is more enthusiastic about breaking up the banks than Mr Osborne.

I suppose you could see the establishment of such a commission as an argument deferred for a year or so between the Mr Osborne and Mr Clegg on whether Barclays and RBS should be allowed to remain in their current colossal form.

Also there appears to have been a slight softening in the Tory commitment to dismantle the City watchdog, the Financial Services Authority.

The Bank of England will be given control of so-called macro-prudential regulation (the contentious question of whether credit should be rationed, as a dampener on potential booms and busts) and it will have "oversight" of micro-prudential, which is the monitoring of individual banks and financial institutions to ensure they're not taking excessive risks.

But the pact between the parties won't be explicit that the bods who do that micro-prudential regulation at the FSA will end up working for the Bank of England - which looks like a move in the regulatory direction preferred by the Lib Dems.

What may shock many investors is that the coalition will more-or-less adopt the Lib Dem's policy on raising the capital gains tax rate to streamline it with income tax. That means the top rate of CGT will be at least 40%, and possibly 50%.

However a much lower rate will be applied to "entrepreneurial" business investment: the higher capital gains tax rate is aimed at extracting more revenue from speculation, but there will in a sense be a return to the system only abandoned by Labour a couple of years ago, where there were significant tax rewards for those who invest in wealth-creating activities for longer.

As I mentioned yesterday (see What a Tory/Lib Dem government would do), the tax priority would be to raise the income tax threshold in the course of the parliament to £10,000, to the benefit primarily of those on lowest pay.

And, as Stephanie said, there'll be a tweaking of the Tory pledge to reverse Labour's National Insurance rise, so that the reversal applies only to the NI paid by business, rather than by individuals.

Meanwhile, as I pointed out, the Tory manifesto promise to increase the inheritance tax threshold to £1m would be kicked into the long grass.

For most investors there will be relief that there will be no pulling back from the Tories' plans to cut the UK's record public sector deficit a bit more and a bit earlier than Labour or the Lib Dems would have done.

So I would expect sterling and the price of government bonds to rise this morning. But with the stamp of Mr Cable on much of the approach to banks and regulation, I think we may see a bit of weakness in banks' share prices.

Update, 08:42: An encouraging sign for the new government is that the rise in the price of government bonds that we saw late yesterday has continued this morning. Nothing dramatic - but it shows that investors have some confidence in the ability of the coalition to make in-roads into the record public-sector deficit.

The gap between the yield on equivalent German and UK government bonds has narrowed, which shows that investors believe the risk of lending to the British government has reduced.

Sterling has lost some of the gains it made against the dollar last night. And share prices have fallen a bit, though nothing too scary.

Update, 10:25: George Osborne and the Treasury will retain formal responsibility for overseeing banks and financial regulation.

However a new ministerial committee will be set up to devise banking policy, which will include Vince Cable as one of its members.

The committee will be chaired by Osborne as chancellor.

It looks as though Cable will be the secretary of state for business.

So what'll happen to Ken Clarke, who did that job in opposition for the Tories?

Update 10:35: BA, Virgin and the airlines may be in for a bit of a shock, because the Lib Dem policy of taxing planes rather than passengers has been adopted, as one of the coalition's green policies.

As I've mentioned, the Lib Dems have agreed to the Tory proposal for an accelerated programme to cut the so-called structural deficit in the public finances, with a £6bn down payment this year.

However the Lib Dems won a concession that part of that £6bn will be deployed for job creation.

A commitment to a new tax or levy on banks is part of their joint programme.

And a significant move towards a £10,000 income tax allowance will be made in the first Budget, due in 50 days.

Update 10:55: One of the most difficult areas of negotiation between the Lib Dems and the Tories was on nuclear power, where the Lib Dems take the view that new nuclear power should not receive a public subsidy of any sort and where they believe that there may be more efficient green generating alternatives for meeting CO2 reduction targets.

In the end, as I understand, nuclear power is one of those areas where the two have agreed to disagree. Which creates considerable uncertainty for the two big companies, EDF and Centrica, that are hoping to role out a series of enormous new nuclear stations.

And they may be alarmed that the person who'll be in charge of whether the new nuclear plant is built, as secretary of state for the environment, will be a leading Lib Dem, Chris Huhne.

Update, 16:53: I understand a leading business figure is likely to be made a peer in order to join the government, in the kind of role that was occupied by the former chairman of Standard Chartered, Mervyn Davies - with on foot in the Business Department and another in the Cabinet Office.

The obvious candidate is Simon Wolfson, chief executive of Next and close chum of Osborne and Cameron. But he's told pals and investors he has no intention of giving up the day job.

What a Tory-Lib Dem government would do

Robert Peston | 17:01 UK time, Tuesday, 11 May 2010


The Tory and Lib Dem negotiators are reaching the final stages of policy negotiations.

Any agreement on ministerial jobs will come later.

This is what I've learned would be some important elements in their joint economic and business policy:

1) The £6bn of additional spending cuts promised by the Tories will stand, unless the economy were to dramatically weaken. A well-placed source said to me that the £6bn wasn't economically important enough to be a stumbling block for the Lib Dems.

2) The Tories will adopt the Lib Dem plan to increase the tax-free allowance on income tax to £10,000. A meaningful initial rise in the allowance would come quickly, with a clear timetable announced to get to the full £10,000.

3) We are not likely to see any meaningful increase in the inheritance tax threshold while the Lib Dems are part of the government. That Tory manifesto pledge would be kicked into the long grass.

To be clear, the ink is not yet even on the de facto contract between the two parties. And there are senior Tories and Lib Dems who fear that if a contract is eventually written, the coalition government may not last long, such is the mistrust between those at the top of the parties.

But my strong sense is that both sides are up for giving it a go - in the "national interest", according to my sources, and not simply to taste the elixir of elected office.

Benchmark gilt down

Robert Peston | 08:19 UK time, Tuesday, 11 May 2010


The 10-year benchmark gilt is falling sharply at the opening. It is now down 0.8, after a weak close last night.

This will make for a tricky auction of £2.25bn of gilts - think of it as the government borrowing £2.25bn - later today.

I'll elaborate on the causes and consequences in a few moments.

But investors are saying they are not enamoured of the uncertainty over whether a strong, determined, deficit-cutting government will be formed.

Update 09:00: To be clear, this is not a rout in gilts. And the weakness of shares - the hangover after yesterday's party fuelled by eurozone stimulants - will help to underpin the bond prices of all the major economies (as a rule that is quite often broken, when stock markets fall, investors look for the relative safety of government bonds).

All of which tells you that making sense of what's been happening in the gilts market has not been simple over the past few day.

So, for example, the weakness in gilts in the earlier part of yesterday might have been due to the returning risk-appetite of investors, prepared again to put their money into equities rather than AAA sovereign debt (and lest we forget, the ratings agencies have again affirmed that they have no immediate plans to slash the UK's AAA rating).

Or the gilts drop may have been the gravitational pull of falling German bond prices.

It was rational that the price of German and French bonds should fall yesterday, after the announcement of the substantial loans-and-liquidity eurozone rescue package.

Germany and France became more explicitly liable for the debts of over-borrowed countries such as Portugal and Spain. So of course the quality of their own debt deteriorated: you are what you eat; or, to be more precise, your credit is only as good as the credit of those who owe you money.

So the fall in German bond prices is an articulation of why so many German citizens are uncomfortable with the creeping integration of the finances of eurozone countries.

But then gilts weakened further, after Gordon Brown removed himself as a possible obstacle to the formation of a Lib-Lab pact.

At that point, investors became less focussed on the financial drama across the channel and started to become anxious that there was no end in sight to negotiations on the formation of a government for this island.

As Terry Smith, chief executive of Tullett Prebon said on the Today programme, all that investors really care about is that someone ends up in charge with the determination and the means to cut public spending and raise taxes, to make a reality of the official forecasts that the UK's record peacetime deficit will be on a pronounced downward trend in the coming years.

His view is that a Tory-led administration would be seen by those who lend to the government as more credible as a cruncher of the deficit.

Which may be right. But all it tells you is that the sine qua non of a successful Lib-Lab coalition is that it would probably have to say considerably more about what it would do to reduce the deficit - and fast - than either Nick Clegg or Gordon Brown said during the general election campaign.

Those at the top of Labour and the Lib Dems are not market ignoramuses. They know that if a Lib-Lab administration looked as though it would be unwilling or unable to make the difficult decisions necessary for restoring the health of the public finances, the fanfare for its inauguration would be a tumbling pound and a soaring cost of what the government has to pay to borrow. Ouch.

That would be a fast route to economic and political mayhem. So presumably messrs Clegg, Cable, Brown and Darling have a cunning plan to avoid all that.

Update 10.48: No sterling crisis yet. Today's auction of gilts seemed to go pretty well.

The government was trying to borrow £2.25bn for repayment in 17 years. Investors offered to lend some £5.6bn.

So in the jargon, the auction was almost 2.5 times covered - viz, investors were willing to buy more gilts than the Debt Management Office needed to sell, by quite a wide margin.

In other words, creditors may be a bit jumpy about how long it is taking to form a new government, but they don't appear to anywhere near going on a lending strike.

Update 11.00: Although it's plainly good news that the gilt auction went pretty well, gilts have weakened today relative to their main comparator or benchmark, German government bonds.

According to Michael Saunders of Citigroup, gilts have fallen today around 0.4 whereas like for like German bonds are up 0.7.

In other words, investors perceive the risk of lending to the British government to have increased reasonably significantly compared to the risk of lending to the German government.

Eurozone crisis is 'postponed'

Robert Peston | 07:21 UK time, Monday, 10 May 2010


Last night eurozone governments and the European Central Bank announced new safety nets for financially overstretched countries and banks.

Euro logoThe first immediate consequences are that we're bound to see a recovery in the euro, a fall in the risk premium for insuring eurozone bank debt and a rise in stock markets.

But many would say the crisis has been postponed rather than solved - and that eurozone countries have a good deal more work to do to remove the serious underlying strains in the euro area.

For investors, probably the most important initiative is that of the European Central Bank, which has said that it will buy up government and private-sector bonds where it sees that markets are becoming "dysfunctional".

What does that mean?

Well a couple of weeks ago, Greek government debt with a two-year maturity was for a very brief period yielding 40% - which was extraordinary for a country that's joined to some of the richest in the world.

In practice it meant that the market for two-year Greek government bonds was closed.

What the ECB has said is that where there is evidence of markets malfunctioning in that way, it will intervene to buy up the relevant securities, to re-start the markets.

However it will not be creating new money in the eurozone in the process of purchasing such bonds, because for every bond shunned by investors that it buys, it will sell other securities back into the secondary market to remove the additional liquidity it has created.

So this should not be seen as an attempt by the eurozone to ease monetary conditions in countries such as Portugal or Ireland, to offset the recessionary impact of public spending cuts and tax rises necessitated by the imperative of reducing their excessive public-sector deficits.

In fact the ECB is standing by its mantra that all eurozone member states face the serious obligation to cut deficits deemed as excessive under the eurozone's founding treaty - which is another way of saying that it won't exploit the strength of Germany's balance sheet in a backdoor way to provide financial succour to weaker eurozone economies.

Even so, if it ends up making significant additional purchases of - for example - Greek and Portuguese government bonds, there are bound to be fears among German taxpayers that they are in effect rescuing their more profligate neighbours. And that if the price of those supposedly lower quality bonds were never to recover, well that would be a permanent loss falling on all eurozone citizens.

In addition to these market purchases, the ECB will lend directly to banks for terms of three months and six months.

And to ease the palpable tensions in the bank-to-bank market for dollar loans - where there have been signs that banks have become less keen to lend to each other for longer periods - there is collective action by the Federal Reserve, the ECB, the Bank of England, the Swiss National Bank and the Bank of Canada.

In essence, the Fed will swap dollars with these other central banks for their respective domestic currencies, and the dollars will then be lent to banks in Europe.

As for the separate 750bn euros initiative by eurozone governments and the International Monetary Fund to provide loans or guarantees to individual eurozone governments that experience difficulties borrowing from investors, that is more ambitious than most bankers and investors had been expecting.

So it'll provide comfort to those lending to - for example - Portugal, Ireland and Spain that there's a de facto guarantee from France and Germany behind the IOU's issued by Portugal, Ireland and Spain.

Three important caveats however.

The actual loans and guarantees may turn out to be harder to deliver than the words of comfort from eurozone government heads.

Second, 750bn euros is just over one-year's new borrowing by eurozone members and a bit more than 10% of eurozone government debt. So it's certainly not enough if investors were to start to lose confidence in the ability of some big countries - such as Spain or Italy - to honour their debts.

Which takes us to the import third caveat. In the end, there won't be a cure for the underlying eurozone strains unless and until the record, unsustainable deficits of some eurozone members are reduced in a permanent way.

Osborne sounded out by euro finance ministers

Robert Peston | 11:31 UK time, Sunday, 9 May 2010


European finance ministers seem to think there's a fair chance George Osborne will end up as chancellor, because a number of them have been in touch with him, to sound him out on the euro bailout plans they are discussing today.

George OsborneBut, to be clear, they don't know anything we don't about the outcome of talks between the Lib Dems and the Tories on forming a government. They're just sensibly hedging their bets.

Osborne like Darling would refuse to allow a British financial contribution to the more ambitious "European Monetary Fund" under discussion. This would have to be an initiative only of eurozone members, if it flies at all.

But Osborne might back the more modest proposal for up to 50bn euros or so in toto of finance for emergency loans to financially stretched eurozone members - with the money to be raised by bonds sold against the security of the European Commission's annual budget.

In other words, his views don't seem terribly different from Darling's (see my note of yesterday).

And, for the avoidance of doubt, if the finance ministers were to announce only the 50bn euros fund, investors would see that as wholly inadequate insurance against a possible collapse of lending to financially stretched European countries.

So when markets open tomorrow, we'd see another alarming flight away from assets perceived as risky, notably the euro, shares and credit for eurozone banks.

Update, 12:08: Just in case any of you thought that Osborne was showing intriguing signs of what the Europeans would call a "communautaire" spirit, I am told there is no guarantee he would back even the smaller stop-gap bailout scheme: he'd have to "see the details", I am told.

Britain to oppose giant euro bailout fund

Robert Peston | 19:11 UK time, Saturday, 8 May 2010


No one seems to know whether the European Central Bank (ECB) will in fact provide backstop liquidity to Europe's squeezed banks - and whether it will go further and create money through quantitative easing to ease economic conditions in countries like Greece and Portugal facing significant fiscal tightening.

Euro coins and notesOfficials and politicians I've spoken to say the ECB is playing its cards close to its chest, though pressure is being applied for it "to do the right thing".

There is talk of the ECB providing some kind of one year repo facility (where government bonds are swapped for 12-month loans) in collaboration with the US Federal Reserve.

We'll see. Certainly for the sake of a bit more stability on markets, something of that sort is required.

What is clear is that European finance ministers will tomorrow approve a scheme that would allow the European Commission to borrow against the security of its budget, and then lend some of the money to eurozone members facing financing pressures.

But the sums of money that will be made available by this approach - which already exists in a small scale way to help financially challenged Hungary, Latvia and Romania - will be relatively small, perhaps 50bn euros in total.

That won't be enough to reassure markets - although it's bound to be controversial in the UK because it effectively puts Britain on the hook for a few billion pounds to bail out eurozone states in difficulties.

However eurozone members want to go further and effectively create Europe's own giant IMF-style fund, with all EU member states clubbing together to guarantee borrowing by troubled individual members.

My strong sense is the Treasury - and today's Chancellor, Alistair Darling - will oppose the creation of such a fund.

He will argue that the IMF already exists, and has both the financial resources and the expertise to do this job. So what's the point of replicating it?

If Darling opposes what one might call a European Monetary Fund, other EU members could go ahead and create such a fund without any financial contribution from the UK - but it would have to be in some sense separate from the institutional structures of the EU.

And I would assume that eurozone finance ministers know there's little point hanging around to see who might succeed Mr Darling in the coming days, because the most likely successor - George Osborne - is likely to be even less sympathetic to the idea of throwing in a few tens of billions of British pounds for the common European good.

The ECB matters more than Clegg

Robert Peston | 13:55 UK time, Saturday, 8 May 2010


For all the implications for the value of sterling and gilts of talks to form a British government, investors are this weekend probably more concerned about negotiations to stabilise the euro involving the European Central Bank (ECB) and European government heads - as Jim O'Neill of Goldman Sachs pointed out on the Today Programme.

Euro signThe big threat, not just to the health of the eurozone economy but to the world's prosperity, is that Continental banks are finding it harder and more expensive to borrow for longer periods on wholesale markers.

That's because their creditors are worried about their substantial loans to overstretched eurozone governments, through their respective holdings of assorted eurozone government bonds.

Bankers and economists see this strain in the financial system as horribly reminiscent of conditions prior to the meltdown of the global banking system 20 months ago.

"If the Europeans 'disappoint' tomorrow it's back to the autumn of 2008", is how an influential banker put it to me.

In simple terms, as you know, if banks can't borrow, they can't lend - which leads to cessation of vital flows of credit, bank collapses and recession.

What investors are looking for, at the least, is some mechanism to allow banks to borrow for a year or so against the collateral of their stocks of Portuguese, Spanish, Italian and other eurozone government bonds.

As an optimal outcome, many investors would want a eurozone version of quantitative easing, where the European Central Bank would buy eurozone government bonds for cash.

This last initiative would be particularly controversial, because it would see eurozone taxpayers indirectly taking on a liability to the financial health of individual eurozone states over which they have no democratic control (so German taxpayers would be exposed via the ECB to Portuguese government bonds and the credit-worthiness of the Portuguese government, for example).

Anyway, depending on whether a credible plan to limit the contagion from Greece's woes is announced tomorrow by the ECB and eurozone ministers, markets will open on Monday in a state of black despair or renewed optimism.

If the eurozone leaders - against most recent precedent - move swiftly to agree an ambitious, practical euro bailout package, the chances are that there'll be a boost to the value of riskier assets, especially shares.

The pound would also be a beneficiary, in that our record public-sector deficit means sterling is not viewed as risk free (for all the UK's AAA rating).

So what happens in Europe - rather than in smoker-free rooms of Tories and Lib Dems - will probably determine what happens to the British currency on Monday morning.

If European leaders are seen to organise a workable euro bailout, the pound would recover against the dollar. If they flunk it, well it may be a blackish Monday for shares, gilts and the pound.

As for the possible combination of eurozone political paralysis and no sign of a credible government being formed in the UK, well the market impact of that probably doesn't bear thinking about.

The market consequences of a minority Tory government

Robert Peston | 10:11 UK time, Saturday, 8 May 2010


On BBC Breakfast this morning, Vernon Bogdanor said he had no doubt that there would be a minority Tory government, without explicit support from the Lib Dems, that would limp along till another general election in the autumn.

Now he's seen a good few electoral cycles. And his view is not to be dismissed lightly.

As I said yesterday (see A coalition forged by a sterling crisis), the obstacles in the way of the Lib Dems forming a pact with either the Conservatives or Labour look insuperable.

So what would happen on markets if the Tories do end up governing as minority, with all legislation subject to cross-party negotiation and haggling?

Well, the strong probability, perhaps a racing certainty, is that investors would take fright.

Because although a Tory chancellor could cut some spending without resorting to Commons votes - although not if such cuts involved fundamental structural reforms to public services - any tax rises would have to be put to Parliament.

Investors would be unsettled at the idea that a Conservative finance bill or reconfiguration of the public sector would be vulnerable to being voted down in toto - because confidence in plans to reduce the UK's record peacetime public-sector deficit would be undermined.

In those circumstances it is highly likely that sterling would fall and that the government would find it harder and more expensive to borrow.

Or to put it another way, the warning made during the election campaign by Ken Clarke, the Tory Business Secretary, that the UK could find itself again asking for financial succour from the International Monetary Fund might be prescient rather than alarmist.

Here's the painful irony. If there were another election in the autumn, fought against the backdrop of a flight from sterling, it would be all about the detail of how to slash the £160bn-odd deficit.

That is the debate that many said we should have had over the past few weeks, but didn't - in the view of some - because the party leaders were too frightened to tell voters the painful truth about precisely which public services would be squeezed.

A combination of an indecisive election and pressure from financial markets may make that a debate postponed rather than cancelled.

A coalition forged by a sterling crisis?

Robert Peston | 15:52 UK time, Friday, 7 May 2010


As I have said so often that you're bored with hearing it, investors want a stable government perceived to be tackling the record public-sector deficit in a serious, substantial way.

Pound coinsOnly in those conditions will they continue to lend cheap money to the state.

What investors have heard this afternoon may make them fear that a fiscally credible government is looking a more remote prospect - so I wouldn't be surprised if the price of gilts were to fall further (a fall in the price of gilts or government bonds is the corollary of borrowing becoming more expensive for the government).

Here's the impasse.

The Liberal Democrats hold the balance of power. And senior Lib Dems tell me that there are two non-negotiable conditions for them to prop up a government:

1) There would have to be an unbreakable pledge to hold a referendum on reforming the voting system;

2) Gordon Brown must cease to be prime minister.

The implication of this afternoon's statements by David Cameron and Brown is that only Labour can or will deliver voting reform (Cameron's promise of an enquiry on the issue won't satisfy Lib Dems).

But Brown's colleagues tell me its inconceivable he would give up office as the price of forming a Lib-Lab pact (and anyway, some would say that it would be utterly unacceptable, in a democratic sense, for Labour a second time to pick a prime minister from its own ranks who hadn't led the party though an election).

Or to put it another way, there are reasons why it looks impossible for the Lib Dems to form a coalition or even a loose informal pact with either party.

Of course, where there's a hunger for power, the impossible may suddenly become possible.

Here's the big question.

Will it take a collapse in the price of gilts and the pound - will there need to be almost a full scale sterling crisis - to persuade the party leaders that there's no alternative to some kind of entente that allows the public finances to be fixed?

The smart solution would be to somehow depoliticise what's known as fiscal consolidation, or the process of cutting spending and raising taxes such that the public sector can again live within its means.

Quite how decisions that have a differential impact on different parts of the population can be depoliticised is beyond me.

Which is why senior bankers and investors tell me they fear that the pound and gilts are in for a hairy few days, and possibly something even worse and more enduring.

Eurozone crisis buys Cameron and Brown some time

Robert Peston | 08:40 UK time, Friday, 7 May 2010


The morning after in the City does not look great.

First things first.

RBS logoFor all the optimism generated by Barclays and Lloyds that the worst of the banks' losses are behind us, today's first quarter results from Royal Bank of Scotland - the bank owned 84% by taxpayers - reminds us that the total rehabilitation of that important industry is still some way off.

RBS remained in loss for the three months to the end of March, to the tune of £248m - though that was hugely better than the attributable loss of £765m in the last quarter of 2009.

And the charge for losses on loans and investments going bad remained hideously large at £2.7bn, down from £3.1bn in the immediately preceding quarter.

Which isn't to say that there isn't a healthier looking business in the bits of RBS that won't be sold or wound down, it's just that RBS in the round still looks a huge, bloated, wounded animal.

Second, all global markets are showing the effects of Greek influenza (see my note Will the next government have to fight Greek flu).

There's a flight to putatively safer havens, such as gold and the dollar, and away from the euro.

I'm particularly struck and concerned by the rising price to insure bank debt and the growing reluctance of banks to lend to each other longer than overnight - which indicates, once again, that banks are fearful that horrid stuff may be lurking in their peers and rivals.

The supposed poison inside the belly of the banking beasts is on this occasion their holdings of government bonds issued by the more financially overstretched eurozone countries and also bank loans into what many describe as the still over-valued European property markets (a big hello to those banks that are big in Spanish residential property lending and - some would say - are also too deep into the UK mortgage market).

Investors fear that eurozone governments are in denial about the interlinked fragility of their banks and their economies. Which is why a wave of share selling has been circling the globe for almost 24 hours, since the European Central Bank poured a big bucket of cold water on the notion that it would inject fresh funds and liquidity into all eurozone banks with a concerted and comprehensive programme of government bond purchases.

So Asian stocks dropped in the wake of the astonishingly volatile decline on Wall Street last night, and London shares have opened down almost 2% on average.

Almost all of that is Greek contagion - except perhaps for some of the continued weakness in sterling against the dollar, which may be attributable to investors' fears that a hung parliament delays and muddies the imperative of reducing the UK's record-breaking deficit.

But there's no strong evidence of a flight from sterling or that investors are shunning UK government bonds: gilt prices have actually risen fractionally this morning.

Believe it or not, even with the uncertainty about who will govern us, the UK looks a relatively safe haven compared with much of the eurozone. In other words the turmoil across the channel buys British politicians a bit of additional time to work out who's actually in charge.

Update 9:30: Oh dear. My screen is now showing quite sharp drops in UK government bond prices.

Perhaps the coffee has only just kicked in, but investors have started to say more clearly that they don't like the uncertainty about who runs this place and who - if anyone - will tackle that hulking deficit.

What price sterling in a hung Parliament?

Robert Peston | 22:49 UK time, Thursday, 6 May 2010


For all their putative brilliance at allocating scarce resources, markets find it strikingly difficult to walk and chew gum at the same time.

The singular fixation of investors over the last few days has been the risk of Greece defaulting on its government debt (see my earlier note, "Will the new government have to fight Greek flu").

In those circumstances, investors have tended to view the general election in the UK as an amusing piece of theatre that's of primary interest to the eccentric natives.

Although you'd think investors would notice and care that opinion polls have been saying for weeks that it's very unlikely any single party will have a decisive mandate to govern or a significant majority in Parliament, for them the more important consideration is that the UK is a country out of recession and still in possession of its own currency.

Or to put it another way, investors have spotted that the UK isn't Greece.

Which is why the price of government bonds has been rising over the past few days and also why - until today at least - sterling has also been firm.

However it would be foolish to extrapolate that investors won't care about the actual outcome of the general election.

And what will matter to them most is whether any new government can actually govern.

To be clear, this does not mean that there'll instantly be a flight from sterling and government bonds if the exit poll is correct and the Tories turn out to be the biggest party in the Commons but without a majority - although I am struck that a weakening in sterling today against the dollar continued after that poll was published.

The test for investors of a minority government - or a coalition government - is whether the weight of votes in the Commons would be behind a credible plan to cut spending and raise taxes, so as to reduce the UK's record public-sector deficit.

So a slim majority for any party could well be viewed as a disaster by markets, if any deficit reduction plan was viewed by a powerful intransigent opposition as fair game to vote down.

It is plausible that a minority government which appealed for a national consensus or a solid coalition would be better placed to push through the painful belt-tightening measures.

We've entered the realms of speculation.

But the important point is that - all conspiracy theories aside - when it comes to investors' most important agenda for a new government, viz to restore the health of the public finances, those who finance the UK are largely apolitical.

What they want is an effective government committed to reducing the deficit and they don't care whether that's blue, red, orange or some rainbowish permutation of the three; and what they'd hate would be indecision and denial about the difficult financial choices facing the UK.

And if you want a lesson in the cost of pretending the deficit doesn't matter, look no further than the astonishing volatility and losses in global markets today.

Will the next government have to fight Greek flu?

Robert Peston | 21:48 UK time, Thursday, 6 May 2010


It really is one of those "you-couldn't-make-it-up" moments: with just hours before the polls close in Britain's general election, US stock prices plummeted 9%.

So will the new government inherit responsibility for the second global financial crisis in less than two years?

Well that can't be ruled out.

But share prices in the US have now recovered a bit and - on most of the indices - are now down "only" 3.3% or so.

Which is a significant drop - coming as it does on a day of falling stock markets across the world - if not a catastrophic one.

So what's going on?

Well part of that 9% plunge looks like some fairly major technical hiccup, possibly a "fat finger" erroneous trade of some magnitude.

But even so, there's been a growing trend over the past few days of investors becoming much more nervous about the risk of a second global financial crisis and a return to recession.

That increasing aversion to risk has been visible in the rising price for insuring bank debt, in heightened market volatility, and in a renewed reluctance of banks to lend to each longer than overnight.

Also today we've seen strengthening gold, which is almost always correlated with investor wobbles.

As for the euro, well it remains the currency investors prefer to avoid - and after several days of relative strength, sterling fell a couple of cents against the dollar today, which is a very sharp drop.

What's behind it all?

Well it's the fear of Greek financial flu - or the anxiety that Greece will ultimately be forced to renege on its debts, that investors will then be reluctant to lend to other overstretched eurozone nations, that they too will then have to reschedule what they owe, and that this will generate tens of billions of euros of new losses for big continental banks on their holdings of eurozone bonds.

Achoooo! If eurozone economies were then to take drastic action to cut their deficits, that could lead to an economic slowdown, which could cause an escalation in losses on other bank loans, especially property loans.

For what it's worth, most investors would say the order of tumbling eurozone dominoes - or to extend the viral metaphor, the chain of contagion - runs Greece, then Portugal, then Spain, then Italy.

Were these dominoes to tumble, the world's banks would once again find themselves suffering from shortages of capital and liquidity, they'd again be constrained in their ability to lend, and we'd be back to the misery of contracting economic activity.

Now, for the avoidance of doubt, what I'm talking about is investors' fears - and it would be premature to argue that they'll become self-fulfilling.

But what is palpably clear is that €110bn bailout of Greece has been a flop, if it was supposed to persuade investors that Greece would be able to honour its obligations.

That's hardly surprising when pictures are being beamed around the world of Greek people rioting against austerity measures that - even if implemented - can't guarantee that Greece will be able to pay back all it owes.

And many will be deeply concerned that instead of listening to what markets are saying, the German chancellor Angela Merkel today said investors were simply wrong - and that she and her fellow European government heads were determined to win in what she sees as a battle with markets.

As for the UK, well it's vulnerable because of its combination of an enormous and overstretched banking sector and its record-busting public sector deficit.

That was the unsurprising message of a report today by Moodys, the credit rating agency - which incrementally added to the gloom.

Which means that the next chancellor of the exchequer will be walking a tightrope.

Should the chancellor reduce the public sector deficit too fast, well that would tip the economy back into recession - thus generating new losses for the banks and limiting their ability to provide the finance required for any exit from recession.

But reducing the deficit too slowly would unsettle investors, who might stop providing cheap loans to the public sector, thereby also increasing funding costs for the banks and - again - weakening them.

You can see why the Governor of the Bank of England said - allegedly - that the winner in this general election may soon regret its victory.

BP still in uncharted waters

Robert Peston | 09:31 UK time, Thursday, 6 May 2010


It is 16 days since the explosion on the Deep Water Horizon drilling rig. So I suppose what I found most striking about the interview on this morning's Today Programme with Tony Hayward is that BP's chief executive couldn't say when the oil leak in the Gulf of Mexico would be staunched - and he refused to give any guidance at all about the ultimate cost of the disaster for this £100bn British company.

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Throughout the interview, his rhetoric was positively Churchillian - the leaking oil was being battled, kept at bay, by deployment in the air (a "small airforce" spraying dispersant), on the sea (a flotilla of 100 vessels endeavouring to direct the oil) and on the beaches (more than 4,000 volunteers trained up and paid $10 an hour to protect the coastline).

And he finished with the claim that BP would emerge stronger from the environmental and financial disaster. But it's not at all clear what he means by that.

As of this moment, BP certainly doesn't look a more robust organisation than prior to the accident.

Hayward attributed primary blame to the operator of the fateful rig, Transocean, which was "accountable" for the "safety and operability" of the so-called "blow-out preventer".

The big question, for Hayward, is why this this defence against leaks failed. And if you accept Hayward's analysis, that's a question for Transocean to answer, not BP.

The sun sets over an oil platform waiting to be towed out into the Gulf of Mexico at Port Fourchon in Louisiana, on 4 May 2010

That said, what's clear from the rhetoric of the US administration and President Obama is that the most powerful government on the planet believes that the buck stops in every sense (financial, ethical) with BP, in that the rig was being operated for the benefit of BP and its owners.

And if the blow-out preventer was so important, some will wonder why BP sub-contracted responsibility for it.

There's no doubt where markets think the liability for the mess ends up: BP's share price has fallen 14% since the explosion on 20 April, wiping some £19bn off the value of a company owned by more-or-less every pension fund in the UK.

Is £19bn a sound estimate of the long-term costs to BP, both financial and reputation?

As I mentioned, Hayward could not tell us this morning.

To be clear, the uncertainties are huge and do not lend themselves to precise measurement. But that in itself carries implications for how and where BP and other oil companies drill for oil.

First, there's the uncertainty about when the flow of leaking oil will be reduced.

Overnight, BP has closed a valve attached to the end of a broken drill pipe, from which oil had been escaping. But this is not expected to reduce the escape of oil from the well.

Over the coming weekend, it will place a "containment dome" over the leak, to "plumb" the flow in a more manageable direction - but since this evasive action will take place in deep, dark, hostile depths 1,500 metres beneath sea level, BP can't be certain whether it will succeed.

As for the drilling of a "relief well", work started on 2 May and will take three months.

To put it another way, it's anyone's guess whether the oil will be contained within days or whether this will turn out to be the world's biggest ever oil-related environmental disaster.

Which does raise an important question for the entire oil industry.

As you all know, reserves of easily extractable oil are diminishing, which is why BP and other oil companies are engaged in adventures redolent of Jules Verne and are prospecting for oil many thousands of feet below the sea.

But are the risks of drilling in these inhospitable conditions worth taking, if it's impossible to control and limit the consequences of leaks?

Given that the probability of accidents can't be reduced to zero, the priority is to minimise the consequences of accidents.

But the disaster at Deep Water Horizon seems to indicate that the technology does not exist to minimise those appalling consequences.

So governments may be re-thinking whether deepwater oil is oil worth having.

Tory-backed business letter flops

Robert Peston | 15:04 UK time, Wednesday, 5 May 2010


An attempt backed by the Tories to persuade a group of business leaders to sign a letter warning about the alleged dangers to the UK of a hung parliament has collapsed.

Building on the success of last month's business leaders' letter which opposed Labour's planned increase in National Insurance, the Tories were helping to circulate a letter claiming that the UK's economic prospects would be damaged by a lack of decisive leadership by a new government - and argued that a hung parliament could prevent such decisive leadership.

I understand that among those approached to sign the letter were Sir Martin Sorrell, chief executive of WPP, Sir Stuart Rose, chairman of Marks & Spencer, Charles Dunstone, chief executive of Carphone Warehouse, and Sir Philip Green, owner of Arcadia.

"The letter was not explicitly backing any party, though it was co-ordinated by the Tories" said one of those who was asked to sign. "I was approached by Andrew Feldman for them".

I am told that a number of business leaders refused to sign and others subsequently withdrew their names.

"It looks as though the letter isn't now happening" said the boss of a well-known company. "Without us, perhaps Simon Cowell (who gave a positive assessment of David Cameron in today's Sun) will swing it for the Tories".

A Tory spokesman said that the letter was not his party's initiative although he said it did provide support.

Update 16:00: Sir Philip Green has just telephoned me to put on the record that he and Charles Dunstone personally think that a hung Parliament would be bad for the UK.

They both want to see a decisive election result.

"We want a clear decision on who the new leader is" said Sir Philip. "That leader has to show vision and then have the ability to execute that vision. I can't see how that can happen if there's a hung parliament. Let's be under no illusion: hung parliaments are a bad idea".

So, I suppose, that's what Sir Philip would have said, had the letter I referred to in my earlier note been published.

Update 16.31: My note on the hung-parliament letter that never was seems to have stirred up something of a hornet's nest.

I've now been contacted by Sir Martin Sorrell who says that he won't sign group letters in general, because they are capable of being misunderstood.

But he too would prefer a majority victory in tomorrow's election rather than a hung parliament - though he won't say which party he would like to see forming the government.

He is fearful that any coalition government will find it difficult to make the tough decisions necessary for cutting the UK's record public-sector deficit.

I should point out, for the sake of balance, that by no means everyone in the City and business agrees with Sir Martin, Sir Philip or Mr Dunstone on the perils of a hung Parliament.

And it is not insignificant that neither sterling nor the price of gilts have collapsed since the opinion polls started indicating that a hung Parliament is the most probable outcome to the election.

The cost to the Pru of FSA's intervention

Robert Peston | 12:00 UK time, Wednesday, 5 May 2010


The Financial Services Authority (FSA) has been raising concerns with the Pru about whether it would have enough capital and whether the capital would be in the right places, more-or-less since the totemic British insurer announced it wanted to buy AIA for $35bn.

Prudential logo

So the UK regulator would say there was nothing last-minute in its decision last night to throw a spanner in the deal works. It would argue that the Pru hadn't been listening properly to the concerns it has been raising.

The FSA's intervention matters.

First, it means that the Pru will have to raise more capital. This can be done in a number of ways.

The Pru could increase the size of its planned rights issue. But it was already intending to raise a record-busting £14bn, so the Pru's shareholders would not relish the prospect of stumping up even more money.

Or the Pru could sell one of its existing operations, such as its historic UK life insurer and fund manager.

But as I mentioned in my earlier note, the UK business generates cash, while the Pru's existing and soon-to-be-bought Asian businesses consume bucket-loads of lovely jingling wonga.

So selling the UK may not be a rational option - because, paradoxically, the FSA might decide that if the UK went, the Pru would have to hold relatively more expensive capital relative to assets than would otherwise be the case.

Alternatively, the Pru could raise more lower-quality capital in the debt markets.

Either way, there is no cheap or quick way for the Pru to satisfy the FSA. Although the FSA's hurdles are not insuperable.

That said, the watchdog's intervention will increase the concerns of those Pru shareholders who have reservations about the cost and size of the takeover: you'll recall that I disclosed last month that the Pru's largest shareholders, Capital of the US, which has 12% of the Pru, would prefer the AIA acquisition not to take place.

One final thought: there is powerful symbolism to the FSA's refusal to rubber-stamp the takeover.

It has sent out a powerful signal that it is prepared to publicly embarrass even the mightiest and proudest of City institutions, as and when it is concerned that those institutions may be biting off more than they can comfortably chew.

However, after the appalling banking debacle of 2008 that was caused by banks' reckless expansion in plain sight of the FSA, some might mutter something about horses and barn doors.

FSA delays Pru's record-breaking rights issue

Robert Peston | 08:03 UK time, Wednesday, 5 May 2010


Last minute intervention by the Financial Services Authority (FSA) has led to a delay in the announcement by the Prudential of its record-busting £14bn sale of new shares.

The Pru was hoping to announce the share sale this morning at 0700 BST.

But late last night, it was told by the FSA that the announcement would have to be delayed.

The Pru is raising the money to finance its £23bn takeover of AIA, the Asian offshoot of AIG, the battered US insurer.

I am told that the FSA, the City watchdog, raised concerns about the so-called capital structure of the Prudential as enlarged by the enormous takeover.

Or to put it another way, the FSA remains to be convinced that the Pru will be strong enough in a financial sense when the deal has gone through.

According to a source close to the transaction, the FSA has been less than enthusiastic about the deal from the outset - largely because the bulk of its operations will be in Asia, a long way from both the Pru's HQ and from the FSA.

This is deeply frustrating for the Pru's management - though the Pru is hopeful that the delay will be temporary, perhaps just a day or two.

The Pru believes that both it and AIA are among the best capitalised groups in the world.

However it understands why the FSA would be cautious and conservative in the process of approving the deal.

The dispute over the capital adequacy of the enlarged group relates to the provision of the Insurance Groups Directive.

The regulator has been massively criticised for failing to ensure that banks had enough capital in the run-up to the banking crisis of 2008. In particular, it permitted Royal Bank of Scotland's capital ratios to become wafer-thin on some measures following RBS's massive acquisition of the rump of the Dutch bank ABN.

Financial executives say, however, that if the FSA is seen to be too restrictive of financial firms in London, some may relocate to other financial centres.

The Pru for example, once it is perceived to be a largely Asian group, could move its HQ to Singapore.

Update, 09:08: Very interesting interview with Robin Geffen of fund managers Neptune on Today.

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He fears the consequences for the Pru's financial strength of its likely sale of its UK operations.

For the avoidance of doubt, I do not expect the Pru to announce the sale of its historic domestic business when it finally publishes the rights issue details.

But the eventual disposal of the 140-year-old mother operation remains highly likely, after the AIA deal closes.

As Geffen says, the relevant facts for investors like him about AIA and the Pru's existing Asian business is that they consume cash - which is a corollary of their rapid growth.

Whereas the staid old British life and investment business is a useful generator of cash.

So some, like Geffen, will view the Pru as much less robust if it pulls out of the UK.

And, of course, there would be powerful symbolism if the Man from the Pru no longer had a significant property in Britain.

As for the FSA, would it make sense for it to be the Pru's lead regulator, if the Pru no longer sold policies and investments in Britain?

The challenge for the FSA of monitoring the Pru in those circumstances might be deemed to be excessive.

Political risk premium soars

Robert Peston | 08:32 UK time, Tuesday, 4 May 2010


Before the credit crunch and Great Recession of 2007-8, the great cliche of my milieu was that the power of national governments and politicians was being eroded by globalisation and the clout of those running big multinational companies and financial institutions.

It was a trend. But that trend no longer looks quite as significant as it did.

How so? Well, I can barely remember a time when there have been more enormous stories in my patch, and all of them have at their very heart the actions or reactions of the political elite. Right now, elected politicians look like giants endowed with great strength - which doesn't mean they use that strength responsibly - up against pygmy-ish corporate bosses.

Here is a short, non-comprehensive list of what I am on about:

(1) The most interesting announcements on this morning's London Stock Exchange are the squeals of pain from BHP Billiton and Xstrata, which have laid into the Australian government's weekend announcement of a new 40% tax on the substantial profits earned from mineral and resource extraction in Australia. The Australian government wants the multi-billion dollar tax proceeds to finance tax cuts for other businesses, whose aim is to make corporate contributions into pension schemes more affordable. The fall in the share prices of BHP, Xstrata and Rio Tinto reverberates around the world, and especially in the UK where they represent a significant slug of the overall value of the stock market.

Oil slick(2) Much of the recent drop in BP's share price is the result of uncertainty about the damage to the company's prospects in the US that may result from how politicians and regulators react to the calamitous leak from its oil platform in the Gulf of Mexico. Petroleum is always a political business. But it has become more political than ever, as the environmental risks of its extraction are perceived to have increased in so many different ways.

(3) The fraud charge levelled by the Securities and Exchange Commission against Goldman Sachs is the most visible manifestation of a global trend of financial regulators attempting to tell banks who has the whip hand.

(4) All banks face material uncertainties about future actions by governments and regulators, which will determine what new taxes they may face, what activities they may be forced to withdraw from, how they pay their executives, what stocks of capital and liquid assets they'll be forced to hold, and so on.

(5) Then, of course, there's that refusal by European regulators and governments to trust the judgement of airlines that it was safe to fly around the ash cloud.

(6) Oh, and let's not forget about Greece. There have been months of uncertainty about whether the European Union would bail it out and whether the European Central Bank would continue to provide Greek banks with liquidity against the collateral of downgraded Greek state debt. The rescue of Greece shows both the extent and limitations of public-sector power: it will be some time before we can gauge the true consequences of the significant bailout package, for Greece and for the integrity of the eurozone and European Union.

What do all these stories have in common? Well they all show the extent to which market mechanisms are no longer trusted to sort out societies' assorted challenges and problems - which was a predictable consequence of the Great Recession, but has happened to an extent that may surprise even those who believe in big government.

So any investor has to think very hard indeed when putting money into a business about whether that business is likely to rub up against government in a way that is likely to diminish or - perhaps more rarely these days - enhance value.

Oh, and let's not forget that the outcome of an election taking place in a country called the UK will have big and difficult-to-measure consequences for the private sector.

Or, to put it another way: the political component in the risk premium of investing has soared - though the preponderance of cheap money (another manifestation of state power) may have clouded investors' judgement about the long-term implications and costs of the re-born state.

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