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Archives for June 2010

Crackdown on hedge fund pay

Robert Peston | 18:38 UK time, Wednesday, 30 June 2010


I have learned that the bonuses paid to senior executives at hedge funds and fund managers are to be subject to strict conditions, under new EU-wide rules that have been agreed by EU members states and legislators.

Gherkin building and Canary WharfThis is the first time that there would be any regulation of the pay of hedge fund managers operating in the City of London. There is a strong probability that it will encourage some of them to relocate outside the EU, to financial centres such as Geneva in Switzerland.

I have spoken to a number of senior hedge fund managers, who are shocked their pay is to be regulated. They say that it is "unenforceable" because they will quit the EU.

The new conditions imposed on bonuses paid at hedge funds and other fund managers stem from amendments agreed to the Capital Requirements Directive.

The directive's stipulation on bonuses apply to some 2,500 European Union big investment firms, as well as banks.

Under the new rules, agreed by member states and legislators, only 30% of any bonus for bankers and fund managers could be paid straightaway in cash - and the proportion would fall to a fifth for large bonuses.

At least half of the total bonus would have to be payable in shares or securities linked to the resilience of the institution - and much of the bonus would have to be deferred, with individual countries able to decide how much of the payment should be staggered.

The new rules won't make a big difference to bankers based in London. The Financial Services Authority has already imposed conditions on them which many bankers would see as tougher.

But the rules will have a big impact on hedge funds and other asset management firms.

The FSA is miffed that it will be forced to regulate the pay of these so-called investment firms. It does not believe that the way they are paid contributed to the financial crisis.

It is understood that the Treasury felt powerless to block the reform, which will apply from the end of this year.

The Treasury feels that in general the provisions of the Capital Requirements Directive - which, as its name implies, mainly covers the capital requirements of firms - very much suit the UK's interests.

The rules on the regulation of bonuses go a bit further than the Treasury would have liked, said a source, but it is hopeful that the FSA will implement the rules in a "proportionate" way.

UPDATE 01 July 18:36

Those hedge funds that are not covered by the Capital Requirements Directive (CRD) will face almost identical constraints on their variable pay, under the planned Alternative Investment Fund Managers Directive (AIFM Directive).

According to regulatory sources, the remuneration clauses of the two directives will be "aligned".

So although only a limited number of hedge funds are covered by the CRD, the rest will be swept up in the AIFM Directive's net.

The risks of forcing banks off welfare

Robert Peston | 08:19 UK time, Wednesday, 30 June 2010


There are always moments of anxiety when benefit claimants are weaned off their welfare support.

One such is today, as eurozone banks face up to the refusal of the European Central Bank to roll over €442bn of exceptional one-year loans provided to them by the central bank.

Euro logo outside ECBEurozone banks are hooked on credit provided by - in effect - the public sector. And are fearful of having to fend for themselves.

To be clear, the ECB is not exactly throwing them on to the streets with its decision to demand repayment tomorrow of that €442bn: it is today offering banks as much three-month money as they want.

Which may seem bizarre, in that inevitably the ECB will tomorrow be repaid in part with funds it is providing today.

But central bankers take the view that the rehabilitation of banks requires that they become less dependent on longer term loans provided by the authorities.

See it as the equivalent of moving the long-term unemployed off disability payments and on to a jobseeker's allowance: it's a message to the banks that they have to start to prepare for life back in the real world, where all but their short-term unexpected liquidity needs must come from depositors, wholesale creditors and investors.

For Spanish banks - and also for Greek and Portuguese ones - that real world looks scary right now.

Spain's banks are finding it tough to tap commercial sources of wholesale finance, because of growing fears about potential losses stemming from the weakness of its property sector.

And more-or-less the whole eurozone banking sector - including big German and French banks - is under the dark shadow cast by their huge holdings of eurozone government bonds, because of deep-seated fears that Greece and perhaps other overstretched eurozone states will eventually default on their sizeable debts.

But it would be quite wrong to see the welfare dependency of banks as a purely eurozone phenomenon.

You'll recall that at the peak of the financial crisis in late 2008, public-sector support for the worlds' banks - in the form of loans, guarantees, insurance and investment - was equivalent to a quarter of everything the world produces, or more than $12trillion.
In the UK, support reached a maximum of around £1.3trillion, almost 100% of GDP.

These weren't just a few handouts. This was the biggest co-ordinated financial rescue operation the world had ever seen.

But to avoid a permanent fusing of the balance sheets of banks and the balance sheets of sovereign states, all that emergency financial support has to be unwound.

In the UK, for example, UK banks face a deadline of the end of 2012 to repay £165bn of high-quality liquid assets supplied to them by the Bank of England under the Special Liquidity Scheme.

And over the same timescale, British banks will have to find £120bn to pay back debt that has been guaranteed by the Treasury under the Credit Guarantee Scheme (there is an option to roll over a third of these government guarantees to 2014).

Now as bad luck would have it, this schedule for repaying the Bank of England and the Treasury coincides with a spike in repayments on other substantial debts of British banks, in the form of bonds and residential mortgage-backed securities.

What this means, according to the Bank of England, is that banks need to refinance or replace up to £800bn of term funding and liquid assets over the coming 30 months.

The Bank of England estimates that simply to replace this finance, British banks need to sell about £25bn of new bonds and asset-backed securities every month.

Here's the troubling news: what's required is 66% more debt issuance per month on average by banks than actually took place during the boom years of 2001-7. And banks are currently issuing (selling) less than half the debt that's needed.

Now if you think there's safety in numbers, you might be reassured that French, German and Italian banks also face substantial increases in debts falling due for repayment.

And wherever you look in the rich West, from the US to the eurozone, banks are currently borrowing substantially less on debt markets than they require simply to replace their maturing debts.

It has all the hallmarks of a second credit crunch.

Not a short sharp financial crisis in this case (although that can't be ruled out as a possibility), but a squeeze on the funding available to banks that - barring a miracle - will also squeeze the volume of credit they're able to make available to households and businesses, or to all of us.

As I said, coming off welfare is always painful. And as and when the banks feel pain, we're going to feel it too.

Update, 12:40: Eurozone banks have borrowed 131.9bn euros of three-month money from the ECB, which is about a third less than analysts were predicting.

It certainly implies that strains in the wholesale funding market are less acute than some feared, and that fewer banks than it was thought are being deprived of finance from commercial sources.

That said, 131.9bn euros is a non-trivial sum of money.

And with the market rate for bank-to-bank money on average 25 basis points - or 0.25% - cheaper than ECB money, it would be foolish to argue that eurozone banks are in tip-top condition: no bank would choose to borrow from the ECB, given the financial and reputational cost of doing so, unless it had to do so.

Eurozone banks are still on welfare support.

BBC removes 'gold plate' from pension scheme

Robert Peston | 08:25 UK time, Tuesday, 29 June 2010


In response to a ballooning deficit in its pension fund, the BBC is taking an axe to the benefits provided to employees who contribute to that fund.

Now I wouldn't normally write about this. Why would you wish to share in the private grief of someone who happens to be a member of that fund?

The BBC's news and current affairs programmes and news website have annual agreements with AP, PA, AFP, Allsport and Getty Images for image use. This image has been changed six times at a cost to the licence-fee payer of a few pence in terms of man-hours, which will be made up for in overtime.That said, the BBC is a public-sector organisation, albeit one proud of its independence from government and not financed out of general taxation (apart from the World Service) - and what it is doing may therefore influence how the new coalition sets about reducing the costs and liabilities associated with those supposedly gold-plated final-salary pensions in the rest of the public sector.

One important difference between the BBC's final-salary pensions and much of the public sector is that the BBC has a funded pension scheme, whereas the pensions of state employees (apart from those in local government) are typically paid directly out of general government revenues.

But the distinction has become more academic than it was, following a massive increase in the deficit in the BBC's pension fund (also announced today), from £470m at 1 April 2008 to around £2bn at 1 April 2009.

There'll be a new three-yearly valuation of the current position, but it's thought that the deficit has fallen only a bit from that £2bn (a recent reduction of the benefits paid to those who leave the BBC may have eaten into the deficit).

The trustees of the BBC's scheme believe this more-than quadrupling of the deficit is not a significantly worse performance than that of similar schemes. Some will query that: the 2008-9 deepening of the deficit hole was worse than the average for private-sector funds in deficit, according to data from the Pension Protection Fund (the PPF uses a different valuation method).

That said, the lack of any substantial reduction in the size of the deficit during the past 12 months may have been beyond the control of the funds' advisers and managers. It is largely attributed to a fall in the yield on AA corporate bonds, or the discount rate for putting future liabilities into today's money - when the discount rate falls, the value of liabilities automatically rises (see my post "BT: a blacker pension hole" for a detailed explanation of the link between the price of bonds, the bond yield and the size of a fund's liabilities).

Whatever the cause of the big deficit, the important point is that there is a whopping deficit. And under pensions law introduced by the previous government, it is a very significant debt of the corporation which needs to be closed.

Which is why - at a time when the government is grappling with massive public-sector borrowing - what is happening at the BBC now looks very similar to the pressures on other public-sector pensions.

To state the obvious, closing the pension-scheme deficit while maintaining benefits payable to BBC employees would require a very significant increase in payments into the scheme, from employees and from the BBC. And the BBC's directors have taken the view that licence-fee payers won't tolerate a rising share of the licence fee being deployed to support the future pensions of BBC staff.

This is obviously moot. It'll spark something of a debate within the BBC (ahem).

So what is the BBC actually proposing? Well having already closed the pension scheme to new members in 2006, it now wants to massively reduce the future benefits of some 17,000 contributing members.

There'll be lively debate about whether its plans - very similar to those at Marks & Spencer 18 months ago that sparked massive controversy - are in fact more generous than simply closing the scheme altogether to all future contributions.

This is quite complicated, so bear with me.

In the BBC scheme, the entitlement is that for every year worked an employee can expect to receive an annual sum on retirement equal to 1/60 of his or her annual salary.

So working for a year on a salary of £35,000 generates a pension in retirement of £583.33. And if an employee were to work for the BBC for 40 years and were paid £35,000 in his or her final year, the employees' pension would be 40/60 of £35,000, or 2/3 of £35,000, which is just over £23,000.

Here is where it gets a bit tricky. Working a year will still generate a pension equal to 1/60 of salary, but each of those sixtieths will be worth less than they were.

How on earth can that be?

Well for two reasons. First of all, whatever happens to actual salaries, the pensionable salary of staff will in the future rise by no more than 1% a year.

So if an employee is promoted and receives a 10% increase in salary, that won't generate a 10% increase in pension, as it would have done in the past: it'll only generate a 1% increase in pension.

And there's a second sense in which those sixtieths have become much less valuable.

In the past, those sixtieths were more than protected against the effects of inflation. No longer.

The value of any previously earned pension is currently increased every year by RPI inflation plus 2%. Any new sixtieths will increase in value by 1% per annum, with no protection against inflation.

In other words, even for those approaching the end of their careers who don't expect their salaries to rise much, the real value of future contributions to the scheme has been very significantly reduced (unless of course we're about to enter a period of sustained falling prices or deflation, in which case up-rating the sixtieths by 1% would be top hole).

What does it all mean?

Well, when a BBC employee looks at his or pension statement under the new arrangement, the value of his or her "earned" pension should not change. The pension entitlement already built up should be protected and proofed against inflation (or so I am told). But there will be a fall - in many cases a big fall - in the projected value of the pension aged 60.

For those relatively early in their careers at the BBC, who expect their salaries to rise sharply, the impact will be so great that they would probably be bonkers to make any future contributions to the scheme - though they'd almost certainly want to retain whatever benefits they've already built up.

Even those on relatively high salaries, who don't expect their earnings to rise, will have to think twice about whether it makes sense to continue with contributions.

The changes will inevitably cause a massive outcry among staff, as happens in the growing number of private-sector companies which close their schemes to all future contributions or cap their liabilities in this way (although I should point out that not all stretched companies reduce benefits to this extent: BA, which is arguably in much worse financial shape than the BBC, has kept its seriously indebted schemes open for contributions).

The point is that members of defined benefit or final salary pension schemes almost never read the small print. When they receive a statement from the BBC or another employer saying that if they work till retirement they would receive a salary of £XX,000, they regard that as a cast-iron promise.

So when they're told that it wasn't a promise, but a projection based on variable assumptions, well they tend not to be amused.

I imagine therefore that George Osborne and David Cameron will be looking quite carefully at how and whether the BBC gets its pension changes through. Because if they could impose a similar 1% annual cap on future additions to public-sector employees' pension entitlements, the savings would run to billions of pounds per annum.

Update 1030: On reflection, the inflation plus 2% annual increase in the sixtieths currently eamed by scheme contributors - to which I referred earlier - must be the actuarial assumption of what will happen to salaries for the calculation of scheme liabilities, not the actual formal guarantee to scheme members. Contributors must be receiving protection for their sixtieths equal to RPI inflation - which will now fall to 1% for future sixtieths.

Update 1205: This is where I begin to fear I've stepped through the looking glass, because it looks to me as though the BBC proposals would in fact reduce the value of accrued or earned benefits as well as new ones.

Here's the relevant excerpt from the BBC's booklet on the changes:

"If you choose to remain in the scheme for future service, benefits built up before 1 April 2011 will continue to increase to your retirement (or when you leave the BBC) in line with annual salary increases, limited to 1% each year.
"If you choose to join the DC (defined contribution) plan for future service you will become a 'deferred member' of the scheme and stop building up benefits in the scheme. The benefits you have built up will increase broadly in line with inflation to your retirement".

What that implies is that even members' so-called "earned" pension will only be up-rated between now and retirement at 1%, not at the inflation rate, if they stay in the scheme.

In other words, unless deflation sets in, there would be a real cut in the value not only of future entitlements but also of the pension that contributors had thought was earned and guaranteed.

It appears that only if members leave the scheme can they be certain that past benefits will be up-rated in line with inflation.

There appears therefore to be a big financial incentive for everyone to leave the scheme.

Some may see what the BBC has done as a way of effectively closing the scheme without saying that in so many words.

What is clear is that these reforms are not simple.

Safer banks are banks providing less cheap credit

Robert Peston | 09:48 UK time, Monday, 28 June 2010


Bankers will be relieved at the agreement of the G20 leaders that tough new rules on the amount of capital they have to hold - as protection against losses - will be phased in.

G20 summitTheir fear was that immediate implementation of such rules would undermine the world's fragile economic recovery: in that when they are forced to hold more capital relative to their loans, it typically becomes more expensive for them to provide credit to businesses and households.

This was a sharp concern of banks and governments in the eurozone, because their banks hold relatively less capital and play a particularly central role in financing the economy.

Even so banks will be concerned at the tough language of the leaders' communique, which implies that as and when the new rules are fully implemented, they'll have to hold perhaps four or even five times as much capital as they did before the crisis.

There's a fraught argument yet to come therefore on the timetable for imposing these new safety standards.

The components of the argument will be these:

1) When will the economic recovery be sufficiently entrenched to make it sensible to force banks to build up their stores of capital more than they've done already, at the potential cost of a temporary slowdown in the flow of credit?
2) When it comes to the cost for banks of all this new capital, what is the trade-off between the inevitable increase in the price of capital caused by a surge in demand and the fall that ought to be caused by providers' (investors') perception that the risks of investing in banks has dropped?

When it comes to point 2), there is a vast amount of disingenuous lobbying on both sides, by banks and regulators.

Banks, for example, refuse to recognise that the cost of capital ought to fall over time, if the risks of a meltdown have diminished.

Per contra, regulators and governments are either naive or dishonest in their apparent refusal to acknowledge that the cost of capital for banks has been - and will be - forced up by reforms to ensure that no bank is too big to fail, that never again will taxpayers have to prop up all the creditors and shareholders of banks such as Royal Bank of Scotland or Citigroup.

The point is that - by definition - if you and I as taxpayers are no longer the underwriters of last resort for huge banks, then all the risks fall on shareholders. So of course investors are going to demand a higher return for those increased risks.

We may all agree that never again should governments commit 100% of GDP in the form of loans, guarantees and investments to rescuing the banking system - which is what happened in the UK - but we can't pretend that transferring most of those potential costs to the private sector won't lead to an increase in the price of private-sector funding for banks and of investment in banks.

By insisting that banks stand properly on their own two feet, we are ordaining that their costs rise, that their profits will fall and that their ability to provide cheap credit will be constrained.

The corollary of course is that the risks of lending to sovereign states that have been the de facto guarantors of banks should fall (a big hello to Ireland, Spain, the US and the UK, inter alia - and yes I know that British gilts and US government bonds don't currently seem to contain much of a risk premium commensurate with the respective sizes of their financial sectors, but who still thinks markets are efficient and rational?).

Anyway, to return to the nitty gritty for a moment, if you read the post I put out on Friday you'll have concluded that the British position on all this appears to have prevailed at the G20 summit.

The Bank of England and Treasury wanted the destination of reform to be a significant increase in the amount of capital that banks will have to hold, a buffer system of rising and falling capital ratios geared to the economic weather and an improvement in the quality of capital. And they were prepared for the journey to that destination to be elongated, as the price for winning support for that destination.

Here's the excerpt from the communique that matters: banks will be required to have sufficient capital "to withstand - without extraordinary government support - stresses of a magnitude associated with the recent financial crisis".

What does that mean in practice? Well, extrapolating from taxpayers' bailouts of UBS, Citigroup and Royal Bank of Scotland among many others, it implies that banks would be forced to hold core equity capital equivalent to 10% or more of their risk-weighted assets in the good years, perhaps as much as 12%, falling to a minimum of 4 or 5% during a downturn.

Combined with the introduction of maximum bank leverage ratios, or ceilings on the gross amount banks can lend relative to their capital, this would represent a return to the kind of prudential standards we haven't seen for perhaps 50 years - the more so, if Paul Tucker of the Bank of England gets his way and the risk-weightings attached to different types of loans become subject to continuous review.

Or to put it another way, the new era of so-called austerity is about a good deal more than a squeeze on the public sector: some percentage of the economic growth we enjoyed over the past 20 odd years that was generated by the availability of cheap bank debt, well that's gone.

Will banks' medicine kill them (and us)?

Robert Peston | 00:00 UK time, Friday, 25 June 2010


The firm conviction of most senior bankers I encounter is that Mervyn King and the Bank of England are their implacable enemies, a sort of financial KGB intent on converting them into salaried bureaucrats who should never again be permitted to take a risk or pocket a bonus.

It may therefore come as something of a surprise that the Bank seems to have come round to their point of view that there is something of a conflict between the twin imperatives of embedding our fragile economic recovery and also implementing new rules to make sure banks have enough capital and liquid assets to withstand the next great wave of financial shocks.

Or to express it in the appropriate jargon, the Bank - in its latest Financial Stability Report - says it wants "an extended transition to the new international regulatory regime".

I know this sounds dull in the extreme. But it is the stuff of high-powered negotiation between the leaders of the world's biggest economies: it'll be more-or-less centre stage in Toronto this weekend, at the summit of G20 government heads.

And, what's more, it genuinely matters to you and me. Because it's all about getting the right balance between reducing the likelihood of future taxpayer bailouts of the banks on the one hand and giving banks enough financial freedom to provide the credit essential to entrench the economic recovery.

At issue are three different but related prophylactic measures for the banks, that are being prepared by the Basel Committee on Banking Supervision, for eventual agreement towards the end of this year by the G20.

They are:

1) How much pure loss-absorbing capital should be held by banks in proportion to a risk-weighted measure of their assets?
2) How little of banks' finance should come from unreliable short-term wholesale sources?
3) How binding should a backstop "leverage" rule be, that would put a ceiling on each banks' gross unweighted assets as a multiple of their core equity capital?

As for the Bank of England, it has a particular take on the calibration of any new rules.

It wants there to be two categories of capital: core capital, which if eroded would trigger a resolution programme for a bank (the rescue of depositors at the expense of other creditors); and buffer capital, which would be there to absorb losses in a recession, and which would be augmented in good years.

All this probably sounds like Greek to you (although some would argue that it's a language Greece's own banks and government plainly didn't understand - ha ha).

In the round, such rules limit how much banks can lend and also put a cap on the associated risks they take.

Which seems reasonable, as we rebuild after the worst banking crisis since the 1930s.

But the fear is that if we insist that banks lend less and less riskily relative to their capital at this particular juncture, they'll respond by turning off the credit tap more-or-less completely - and we'll be tipped back into recession.

Now the risk of that dip back into economic misery is greatest in the eurozone - partly because its economy is so fragile (a big hello to those Greeks again) and because its banks have rather less capital as a proportion of their assets than either the UK's or America's (please see my note of last Friday on those looming and important new tests of the strength of Europe's banks),

Which means that if the UK and US insisted new Basel rules had to be implemented in a year or two, there'd be a loud "non" and "nein" from Paris and Berlin.

So the Bank of England and the Treasury have come round to the view that the priority is to secure broad international agreement on new safety measures that are genuinely robust - and that they are therefore prepared to be as flexible as possible on implementation dates.

For what its worth, most bankers believe that a sensible implementation period would be a decade.

Which may sound like "never" to you. But banks' fear - and the Bank of England acknowledges it's a real fear - is that a more immediate target date might just as well be tomorrow, because banks' owners and creditors would instruct them to get ahead of the game.

What's the right transition schedule? Really hard to say, but probably five years or more.

The big point, as you'll have gathered by now (I hope) is that seemingly sensible reforms to strengthen the banking system - even delayed reforms - could in fact weaken banks, by weakening the economy.

UPDATE 06:45

If you are looking for a capitalist conspiracy, you might notice that governments - especially European ones - seem keener to cut public-sector debt and public services than banking debt and leverage.

There is a choice here. Doing both at once in a very substantial way would probably guarantee a return to painful recession: the combination of lower state spending and a simultaneous reduction in bank lending would be vicious.

Some would say that banks and bankers should be grateful that governments - including our own - seem to have chosen to preserve bankers' way of life, at the cost of scaling back public services.

How are bankers choosing to repay the favour?

Well we'll see whether they manage to sustain the flow of credit necessary to keeping the recovery on track.

In that context, the Bank of England's new Financial Stability Report contains a chart that should probably be studied by all finance ministers and bank shareholders.

It is Chart 4.22 on page 54 (PDF). And it shows the proportion of banks' revenues that they have been paying out both in dividends to shareholders and in compensation to staff over the past few years.

What it demonstrates is that after the banking crisis of 2008, there has been a very sharp drop in dividend payments but a rise in the share of banks' income allocated to salaries and bonuses.

Which is striking, because it indicates that banks' owners have apparently been happy to make significant financial sacrifices while bankers preserved and possibly enhanced their own living standards. Or perhaps those investors just haven't noticed the uneven distribution of financial pain (which would be more worrying).

What the Bank of England helpfully points out is that if dividend payments as a share of revenues were kept at the levels of 2009, but compensation ratios reverted to pre-crisis levels, banks would retain an additional £10bn of earnings.

This would represent £10bn of new capital, which could support - says the Bank of England - some £50bn of additional lending in the UK.

If the banks simultaneously cut both pay and dividends (or paid those dividends in shares), the banks could provide even more useful credit to businesses and households.

Which is a formula for public gain from private belt-tightening that could well commend itself to the new Chancellor, George Osborne, as he frets about the economic affects of the unprecedented public-sector belt-tightening he has imposed.

A tax on Lloyds, Royal Bank of Scotland and Barclays

Robert Peston | 21:12 UK time, Tuesday, 22 June 2010


British banks might think they got off lightly.

The new bank levy announced by the Chancellor George Osborne will raise more than double the £1bn he said would be generated from such a tax when outlining his plans prior to the election - or £2.5bn a year by 2013/14.

But that £2.5bn is a fraction of what the Tories' coalition partners, the Liberal Democrats, wanted to extract from the banks.

And the tax rate - 0.04% next year, rising to 0.07 in 2012/13 - is well short of the 0.15% rate proposed by President Obama (although his tax would die after a bit more than $100bn has been raised).

Which probably explains why banks' share prices didn't move much today (Lloyds up, RBS up less, Barclays down a bit).

So the prevailing mood in the Treasury tonight will be one of slight frustration that they didn't set the rate a bit higher to raise more incredibly useful wonga, given that investors were plainly discounting something worse.

That said, the levy - which is fixed only in the generality, and will be implemented in January after a period of consultation - is an important new tax.

That 0.07% rate will apply to banks' total liabilities, minus Tier capital, insured retail deposits, repos secured on sovereign debt and policyholder liabilities of retail insurance businesses within banking groups.

If that's all gobbledegook to you, I will attempt to translate.

The charge will be levied on that part of a banks' funding that is perceived to be less reliable, viz the money provided by other banks, financial institutions and wholesale creditors. This is the finance which dried up in the summer of 2007 and started the chain of calamities known as the credit crunch - which in turn precipitated the great recession of 2008-9.

So excluded from the levy will be capital that is there to absorb losses, deposits from the likes of you and me - those oh-so-dependable retail deposits - and most financing provided by central banks. What's more there will be a lower levy rate - 0.02% rising to 0.35% - on wholesale funding where the repayment date is more than a year away.

In other words, there are two ways of looking at this levy: as a money raising exercise; and as a penalty for banks perceived to be financing themselves in risky ways with the potential to impose costs on society, on taxpayers, if it all goes wrong.

Or to put it another way, the government is signalling that it wants banks to reduce their dependence on such wholesale funding.

Which may seem like a good thing.

Except that our biggest banks have for some years provided many tens of billions of pounds of loans - especially mortgages - on the back of such wholesale finance.

So if they were to reduce their dependence on wholesale finance, there is a reasonable probability that they would cut back on the useful credit they provide to households and businesses, especially in the short term.

Which would not necessarily be such a good thing while the economy remains somewhat fragile.

That said, the levy has been calibrated at such a low rate that it would probably be wrong to expect massive behavioural changes - apart, that is, from the reduction in dependence on wholesale finance that is being independently demanded by regulators.

So which banks will pay the most?

Well no bank with eligible liabilities less than £20bn will pay a bean. Which would certainly rule out most of the building societies and smaller banks - although on the basis of its 2009 balance sheet, Nationwide would pay the levy.

But the tax would be applied to the global consolidated balance sheets of British banks, the UK subsidiaries or branch balance sheets of foreign banks, and the balance sheets of UK banks that are part of non-banking groups.

What that says to me is that Lloyds, Royal Bank of Scotland and Barclays will all pay a fair whack - because each of them are significant users of wholesale funding, and have very substantial balance sheets.

But HSBC and Standard Chartered will get off pretty lightly, because they are relatively light users of wholesale money and they finance most of their lending through customer deposits.

Which may be just as well, because HSBC and Standard Chartered are the two banks which would find it easiest to relocate their head offices to parts of the world where there's unlikely to be such a levy (in their case, Hong Kong and Singapore, respectively).

As for the related danger, that this levy on the UK operations of the likes of Deutsche Bank, BNP, Goldman and so on will persuade those banks to emigrate from the City of London - thus depriving the UK of employment and other tax revenues - that's much less likely to happen if the US presses ahead with the bank tax I mentioned above and the likes of Germany and France make good on their promise to impose similar taxes.

So long as the home countries of the biggest banks operating in the City also impose new bank taxes, the UK economy can prevent a mass exodus of banks - so long as arrangements are put in place to prevent these banks being taxed twice (which the Treasury says is part of the plan).

That, of course, only confirms my view that when the dust settles, this tax will end up being paid mainly by the troika of Lloyds, Royal Bank and Barclays - and can therefore perhaps be seen as permanent punishment for the way they held the economy to ransom in late 2008.

Budget: Private sector likely to applaud

Robert Peston | 14:25 UK time, Tuesday, 22 June 2010


The market reaction to the Budget seems fairly rational: a rise in the price of government debt; a fall in sterling; a drop in bank share prices; a modest fall in some retail shares.

How so?

Well, lenders to the government were bound to like Mr Osborne's plan to accelerate plans to reduce the deficit and start reducing the national debt as a share of GDP from 2015/16.

Even this year, the volume of gilt issuance will be £20bn lower than the March forecast at £165bn.

Sterling's weakness reflects the likelihood that the Bank of England will keep interest rates lower for longer, in response to the public-sector squeeze.

And what a squeeze! The numbers on pages 40 to 41 of the Budget book - which has reverted to the traditional simple red crepe binding - are remarkable: a cumulative aggregated retrenchment of £120bn over five years.

The state is being shrunk significantly: the share of the private sector in the economy is put on to a serious rising trend, absent some kind of shock that tips us back into recession.

As for the banks: well, some may say they got off lightly, with a levy to raise a maximum of £2.5bn by 2013-14.

It will be a tax on the total size of their balance sheets, minus their insured retail deposits and their capital, and with a lower rate applicable to longer-term wholesale funding.

Budget Osborne

On that basis, I would expect Lloyds and Royal Bank of Scotland - the semi-nationalised banks - to make the biggest proportionate contributions, with Lloyds most exposed relative to its size.

Barclays should also pay a good chunk.

As for HSBC, given that almost all its UK lending is financed by customer deposits, it would pay proportionately less. Which is perhaps a reward for its prudence in never becoming dangerously reliant on undependable wholesale finance.

One big immediate question is whether the tax will deter Lloyds - an important bank - from lending as much as the economy needs.

The deferred rise in VAT to raise £12.1bn and rising a year from 2011/12 is a significant anxiety for retailers and other consumer-facing businesses. That said, many would argue that the UK became too dependent on retail spending in the boom years running up to 2007.

Manufacturers will probably breathe a sigh of relief that the reduction in capital allowances is more modest than expected - raising £3.1bn by 2013-14.

By then, reductions in the headline rates of corporation tax should give £3.4bn back to business, rising to £4.1bn in the following year.

What of the planned tax rise that sparked the greatest controversy in the weeks preceding this historic Budget, capital gains tax?

In the end, those on basic-rate tax won't see any CGT tax increase - and the rate for those on higher income-tax rates will rise to just 28%, far less than the 50% top rate of income tax.

The net take from that CGT change will be less than £1bn. Which few would argue, probably, would drown the enterprise baby.

Update 1655: I said that the response of markets to the Budget was rational.

But I note that by the close, there had been a modest 1% or more rise in the share prices of the likes of Next, M&S and Home Retail (the owner of Argos).

Which seems odd, in view of the looming VAT rise, which surely ought to put something of a chill into consumer spending.

But maybe investors reckon that what matters more to the fortunes of shops is the likelihood that interest rates will stay lower for longer.

As for the banks, the bounce in Lloyds' shares and the absence of any significant move in RBS's share price may simply tell us that investors were expecting a rather more swingeing levy.

In the round, this Budget won't be seen as anti-business, even if there are (predictable) howls of pain from some quarters (private equity says that the CGT increase will hurt the supply of risk capital to entrepreneurial wealth creators).

And that matters to the chancellor - and probably to the rest of us. Because the growth forecasts that underpin the Budget (prepared for him by the newly-created Office for Budget Responsibility) depend on a sharp recovery in business confidence and a significant bounce in business investment.

Without that investment bounce, next year's fairly tepid economic growth would be more than a third lower.

Has there been a bigger Budget?

Robert Peston | 07:27 UK time, Tuesday, 22 June 2010


I've taken a fairly close interest in around 30 Budgets. I've also spoken to others who've worked on or observed 40 or 50 of them. And all of us reckon that today's Budget will be pretty unusual, in that it will combine big changes to the path of public spending with sweeping tax reforms.

Budget boxThere have been many big Budgets in the post-war era. Within my living memory, there've been the important crisis Budgets in response to recessions in the mid 1970s, early 1980s, and early 1990s.

There have been tax-reforming Budgets such as Nigel Lawson's in the mid 1980s and Geoffrey Howe's 1979 one, shortly after Margaret Thatcher was elected, which shifted the burden of taxation from direct taxes to indirect taxes.

And there was the 2002 Budget that increased National Insurance and confirmed that the UK was on a path of steeply rising public expenditure.

It is however rare for a Budget to contain both an overhaul of the taxation system and a significant shift in the boundary between public sector and private sector.

Stephanie Flanders, as economics editor, will guide you through this brave new fiscal world after it's unveiled.

And if I look at the areas that are of most concern to me as business editor, I am expecting big stuff.

There will be details about a new tax on the liabilities of banks to raise billions of pounds a year.

There will be an increase in the rate of capital gains tax - with much of my interest being focused on how the pain for entrepreneurs is kept to a minimum.

There will be moves towards a simpler corporation tax system: falls in the headline rates will be financed by the abolition of certain allowances for businesses. And in this case I'll be keen to see if the Chancellor, George Osborne, has found a way to allay the anxieties of manufacturers that their net tax burden would increase.

I'll also be looking out for evidence that Mr Osborne is translating into deeds the concerns he raised in opposition about what he perceived as the unhealthy structure of the British economy.

So, for example, he argued that economic growth in the boom years from 1992 to 2007 was too dependent on consumer spending and rising levels of household and business debt (or leverage).

In opposition, he floated the idea he might limit the tax deductibility of interest for businesses, to reduce the advantage of financing investment and growth with debt. Will he today initiate a study of how to do that?

And if he still wants to rebalance the economy away from consumer spending, he could have a reason for pushing up the VAT rate that would be - in his terms - a little more principled than his burning need for more wonga to reduce public-sector borrowing.

The retail and consumer sector would, of course, go "ouch".

Separate and related to all that, Osborne has argued that we all need to save more. Will there be any new incentives to save for a pension, for example? And what has happened to the Tory pledge to restore the tax advantages of pension funds which were removed by the last government?

Of course I'll also be looking to see how the new lower path for public expenditure interacts with and affects growth forecasts - and at whether investors and the notorious credit rating agencies will see the British state as better or worse positioned to pay its debts.

Finally there's the important issue of unexpected consequences - and it would be extraordinary if there were none of those.

To repeat, this will be a huge Budget, put together in a hurry, and in the unusual circumstances of marrying the hopes and ambitions of two parties, the Tories and Liberal Democrats.

Seen in that way, it is both unique and quite risky. There must be a fair old probability that it will contain a measure whose effect will be precisely the opposite of that intended.

What springs to mind was Nigel Lawson's decision as chancellor in 1988 to defer new limitations on who could claim tax relief on mortgage interest, which sparked off the mother of all unsustainable house-price booms.

I only hope that late nights and early mornings at the Treasury haven't allowed a howler of that sort to slip into that red box.

Pension commission's job: To avert national bankruptcy

Robert Peston | 12:32 UK time, Monday, 21 June 2010


If you are one of 11 million members of public-sector pension schemes, then you are a fortunate person.

Unless you think that the British government is about to go bust (and of course I've noticed that some of you do), then you can be 100% confident that the pension benefits you've accrued will be honoured.

As Stephanie Flanders pointed out a few days ago, there's not the faintest chance that the government will attempt to renege on past promises to pensioners.

John HuttonThe thinking of the commission set up by the Treasury and chaired by the former Labour minister John Hutton to review public-sector pensions may turn out to be unthinkable, to coin a phrase. But even then it won't suggest that the government should walk away from the explicit pension pledge it gave (and gives) to all those millions of its employees that they can expect to receive guaranteed incomes in retirement that are explicitly and directly linked to the years of service they've given.

However, what the commission will examine is whether the government should and can continue to make a pledge that future service will be rewarded in the same way.

There are three broad options:

1) maintain the status quo;
2) prohibit new employees from joining the schemes (what's known as closing the schemes to new members);
3) close the schemes to contributions.

So what do all the state pension schemes - for teachers, firemen, NHS employees, civil servants, and so on - actually cost?

Well there are two numbers to look at.

First there's the liability for all those past pension promises, expressed in today's money, which the Government Actuary's Department estimates as £770bn at 31 March 2008, or a bit more than 55% of GDP.

The new Office for Budget Responsibility in effect endorsed this number in its report last week.

To be clear, this £770bn total aggregated cost applies only to those public-sector schemes that aren't backed by any assets. It is a liability for so-called pay-as-you-go schemes, where today's pension payments are funded out of government revenues - our taxes and modest contributions from public sector workers - rather than an investment pot.

According to the actuaries department, as of the spring of 2008, there were 7.5m individuals who are dependent for the next 60 to 70 years on such schemes for their current and future pensions

Now, I don't want to worry you, but that £770bn number is arguably too low. It is calculated as if the IOU had been given by a private-sector employer; for those who care about these things, the future payments to pensioners are turned into today's money using a AA corporate bond discount rate - stay awake!

But because a public sector IOU is arguably more dependable and valuable than a private sector IOU, the discount rate should probably be lower, to reflect the lesser risk of being owed money by the public sector. And that would mean the total liability should perhaps be seen as closer to £1tn.

That said, this is probably an argument of academic rather than practical significance - in that £770bn is such a huge number that it does the job of focussing the mind perfectly adequately. It screams "Houston, we have a problem". Because if taxpayers were asked to stump up £1tn or £770bn right now, well we couldn't do it: the UK would indeed be bust, kaput, on Skid Row.

The primary job of the Hutton Commission will therefore be to come up with scenarios for stemming the increase in that liability.

Which brings us to the second really important number, which is the annual increase in that overall liability.

According to the Office for Budget Responsibility, the liability for those unfunded pay-as-you-go schemes increased by £26bn in the year end March 31 2008.

Which is serious money. But is probably - as the pensions expert John Ralfe points out - about £4bn too low, because (again) those liabilities are being evaluated on the basis of a private-sector risk of default rather than a lower public sector one.

Let's assume that the annual increase in the liability was actually £30bn. That's equivalent to about 2% of GDP. So non-trivial.

Here's the shocking statistic that Ralfe has uncovered.

He says the published annual cost of all the pension promises in the official financial accounts of various public-sector bodies is only £15bn - or about half the actual cost.

How on earth could that be?

Well it's because in 2001 the Treasury did something which Ralfe would see as spectacularly reckless - and many of you may agree.

The Treasury fixed, apparently for all time, the rate at which future public-sector pension liabilities are discounted or translated into today's money at 3.5% real.

Arguably this is more than three times the risk-free discount rate which the public sector should be using.

The effect of it has been to reduce the pension liabilities that individual public-sector institutions think they face and to massively reduce the cash contributions to pensions made by those institutions.

It means that a typical public-sector body will ask its staff to contribute perhaps five or 6% of salary to a scheme, with the employer contributing around 15% - for a total contribution equivalent to around 20% of salary.

By comparison, those few comparable final salary schemes that still exist in the private sector would demand aggregate employer and employee contributions of around 30% of salary.

To put it another way, the many billions of pounds paid by taxpayers and public-sector workers for their pensions are too low to the tune of at least 50%.

So it's difficult to see how public-sector pension schemes can be kept open without either a massive 50% or so increase in contributions by both employees and employers - which in this case is really us, as taxpayers - or a massive reduction in the benefits received by future pensioners.

In the case of that apparently necessary increase in the employer or taxpayer contribution, what we're really talking about is the recognition today of what we'd have to pay in the future.

And the moment we own up that the liability is real, that's the moment when it's clear that we have far less money than we thought to spend on schools, hospitals and all those other public services we care about.

Which is an unsettling idea just a few hours before the government is due to unveil a historic, record-breaking squeeze on state spending that's a response to the burden of the public sector's conventional debt, and takes no account of the hidden debt of its pension promises.

Hayward's departure: 'Not if, but when'

Robert Peston | 19:07 UK time, Sunday, 20 June 2010


Tony Hayward looks like a dead chief executive walking.

Having spoken to those at the top of BP, none can come up with a scenario in which Mr Hayward stays at the helm of the bedraggled oil company longer than the proper capping of the leaking well and some kind of quantification of the financial damage.

How so?

It's not (or at least not yet) the result of the forensic investigations of who precisely was to blame both for the explosion on the Deepwater Horizon and the absence of a reliable process for stemming the leak.

Nor is it the direct consequence of Mr Hayward's hat-trick of public relations own goals, from the plea to reclaim his private life, to his refusal to answer questions put to him by a Congressional subcommittee on Thursday, to yesterday's participation in a JP Morgan yacht race around the Isle of Wight.

It's simpler than all that.

BP has suffered the kind of blow to its finances and its reputation (dividend suspended, share price down 45%, credit rating trashed, viewed as contemptible in much of America) , from which rehabilitation is impossible without a change of leadership - or at least, that is what those with significant influence over this business have, with a heavy heart, concluded.

That said, BP's directors would prefer that Mr Hayward isn't forced out by the weight of US political pressure too quickly.

Why would that be?

Well, right now Mr Hayward is performing an incredibly valuable service to BP.

He is absorbing most of the opprobrium heaped on BP by the White House, Congress, the media and Gulf Coast residents.

The danger of replacing him now is that his successor would quickly be tainted - and could then become a lame duck rather than a new start.

It's all a bit redolent of the board's preference to delay the suspension of the dividend - which turned out to be impossible.

What may have made it harder for Mr Hayward to linger on the bridge of this vast lumbering supertanker of a company was Friday's interview on Sky with BP's chairman, Carl-Henric Svanberg.

The important background here is that the British boardroom tradition is that unless a chief executive is minutes from being sacked, the duty of the chairman is to say that he's doing a tip-top job.

The chairman may harbour doubts. But unless and until the dagger is firmly planted between the chief executive's shoulder blades, the chairman is not supposed to give a hint of those doubts to the wider public - for the good reason that it is pretty difficult for a chief executive to do the job if the owners and employees of the company fear that his or her days may be numbered.

In the face of savage criticism of Mr Hayward, Mr Svanberg did not once leap to his chief executive's defence. All he would say is that he would not judge his colleague prior to receiving the conclusions of assorted probes into the Gulf of Mexico debacle.

So if Mr Hayward has a growing sense of his own impending professional doom, he probably needs to look no further than to his own chairman for the cause.

Of course it may simply be that Mr Svanberg, a Swede who has never before chaired any company, let alone a British one - with all their idiosyncrasies - may not know that a chief executive can be damned in the UK by the mere absence of conspicuous backing from the chairman.

If Mr Svanberg is standing behind Mr Hayward, he'd probably better say so, pretty sharpish - lest Mr Hayward's authority diminishes so much that he can't even stay on as the loyal caretaker who absorbs all those blows.

Will European governments have to inject capital?

Robert Peston | 13:15 UK time, Friday, 18 June 2010


In the context of the eurozone's financial crisis, it is gripping that European Union leaders yesterday agreed to carry out stress tests on the region's 25 biggest banks (including the UK's big five).

Jose Luis Rodriguez Zapatero and David CameronHowever, this decision - made under pressure from the American government in particular - to assess whether those banks can withstand whatever economic storms lie ahead raises rather more questions than it answers.

Here are just a few of the relevant issues:

1) Will Greek sovereign debt on the balance sheets of European banks be valued on the basis of Greece's realistic prospects of repaying 100 cents for every borrowed euro - which most analysts would say are close to zero - or on the basis that for a period at least the rest of the eurozone is underwriting Greece's refinancing requirements? The first approach would crystallise perhaps €150bn of losses and the second zero losses.

2) In a more general sense, will the stress tests attach any probability to the possibility of default by other eurozone sovereign borrowers, or will it simply assume the success - which is by no means guaranteed - of the eurozone's and IMF's €750bn bailout package?

3) With the results of the stress tests due in just a month or so, can European financial regulators really assess with any degree of confidence the vulnerability of banks to Spain's frail property market?

4) What weight will be attached to the excessive dependence of European banks on unreliable finance from wholesale markets? Or will the stress tests assume, in what investors will see as a naive way, that the European Central Bank will always be there to lend and support any banks facing a short-term financing crisis?

5) Will the capital adequacy and liquidity of banks be assessed on the basis of the wholly discredited Basel ll rules, the European Union's evolving plans for tougher capital and liquidity requirements, the yet-to-be agreed Basel lll rules or some interim compromise? This is a really vital question. Because it will make all the difference between whether European banks are forced to raise many billions of euros of new capital or whether there's an attempt to pretend that no big European bank needs to raise significant amounts of new capital.

There's little doubt in my mind that this will be a fraught exercise.

If, for example, European regulators adopted the approach taken last year by the Financial Services Authority - of saying that banks need to maintain a 4% ratio of core tier-one capital to assets throughout a cycle that could see us falling back into recession and further falls in property prices - well that would probably require significant sums of new capital to be raised by a number of European banks.

As it happens, British banks, having already been through this exercise, probably wouldn't need new capital right now - although some would on the basis of the direction of travel of the Basel Committee on Banking Supervision (but that's a story for another day).

But if capital is required by some big Spanish, or French, or Italian, or German banks, where will it come from?

Well, eurozone governments probably can't take for granted that private-sector investors will stump up all the necessary cash, in these fraught times. There may well be a requirement for individual states and their taxpayers to underwrite these fund-raising exercises - and we could see partial nationalisation of a few banks.

In other words, European governments face a very difficult judgement, having agreed to carry out these stress tests.

If the tests are rigorous and credible, then they may find themselves in the uncomfortable position of having to invest increasingly scarce public-sector cash into their banks.

But if the tests are perceived by investors to be a weak fudge, then they risk undermining confidence in banks that remain dependent on the support of private-sector creditors and investors for their survival.

Why BP suspended the dividend

Robert Peston | 17:01 UK time, Thursday, 17 June 2010


Late last night, our time, I asked Carl-Henric Svanberg whether events in the credit markets, and in particular the astonishing increase in the premium for insuring BP's debt, had contributed to the board's decision to suspend dividends until at least the end of the year.

OilThose of you who work in financial markets will presumably be unsurprised that he said that it was an important factor in the board's humiliating decision, because what happened to BP's debt insurance premium - or, more properly, to its credit default swap (CDS) premium - was quite remarkable.

Anyone wanting to insure loans to BP of six months or a year had to pay well over 1,000 basis points or 10 percentage points.

What does that mean? Well, a lender wishing to protect itself against any losses on a $10m loan to BP had to pay $1m for that protection.

Here's one way of looking at this.

If you believe that in the event of BP collapsing into administration, the losses on loans to BP would - for argument's sake - be 20 cents in the dollar, then a 10% CDS spread implies that the market's assessment of the probability of BP going bust is 50%.

Which is quite shocking.

Naturally, when BP's creditors take such a dim view of a company's financial prospects, it has to conserve as much cash as possible. Which means there's no way it can pay a dividend that consumes more than $10bn of cash every year.

That said, sometimes these CDS prices are utterly misleading, because the market in them is thin. But there is a substantial market in BP credit default swaps.

And the reason I'm boring on about all this is that a number of senior BP people - including members of the board - have volunteered to me that what worried them most was what was happening to the CDS price.

Here's some context: in March, before the Deepwater Horizon disaster, the CDS spreads on six-month and year loans to BP were 22 and 23.9 basis points respectively.

So insuring $10m of debt back then cost just over $20,000 - which is a bit less than the debt insurance premium on a rock-solid company like Tesco.

To put it another way, the Gulf of Mexico debacle has increased the cost of insuring BP's shorter-term debt by a factor of 50.

There are other ways of seeing the damage wreaked by the rise in the CDS price.

It means that if BP wanted to borrow for six months or a year, the rate of interest it would have to pay would rise to almost prohibitive levels.

Also those who do business with BP on credit could be deterred by the cost of insuring that credit.

To put it another way, the sharp jump in the CDS spread could have become a self-fulfilling event: if BP were unable to trade on credit, it would be bust.

So what's happened since the dividend has been culled?

Well, the one-year CDS spread has fallen several hundred basis points to somewhere over 500.


But even a debt-insurance premium of more than 500 points remains grotesquely high for a company that's supposed to be one of the world's safest.

BP remains many many miles from normal.

Bank of England: Owner of punchbowl or punchbag?

Robert Peston | 08:16 UK time, Thursday, 17 June 2010


The governor of the Bank of England says that the point of putting his organisation in charge of both making sure that markets aren't overheating and that individual banks aren't taking crazy risks is so that a single authority has the power and confidence to take the punchbowl of booze away when dangerous euphoria is gripping financial firms and the rest of us.

George Osborne, Mervyn King and Danny Alexander attend the Lord Mayor's Dinner to the Bankers and Merchants of the City of LondonBut there's another way of looking at George Osborne's dismantling of the Financial Services Authority - and that's to say that successful regulation requires there to be a single punchbag for as and when things go wrong.

Or to put it another way, if the Bank of England knows that it alone will be walloped when there's another financial debacle, possibly it'll do its job in a more determined and focussed way than the previous so called tripartite regime, where responsibility was divided between the FSA, the Bank of England and the Treasury.

Will it work?

That's impossible to say.

If you look at the developed country perceived to have come through the great financial storm of 2007-8 in best shape, Canada, its system of banking regulation has things in common both with the UK's old system and its new system.

Its Office of the Superintendent of Financial Institutions is separate from the central bank - and reports to the Canadian finance ministry.

But that regulator has a narrow role of preventing banks taking excessive risks; unlike our FSA, it doesn't also have the responsibility of protecting consumers from being ripped off.

That said, there is a logic to the chancellor's reforms.

Which is why most concern about those changes focuses on what's known as the execution risk, or that for the two-year period of transition to the new system the FSA will not have its eye on the ball.

And that's profoundly worrying, given that we're seeing serious signs of strain in the financial system once again - with there being, as you know if you read this blog, a genuine and worrying prospect of a second wave of banking disasters emanating from financially overstretched eurozone countries.

So Mr Osborne had quite a coup last night in persuading Hector Sants to abandon his previous intention of quitting as the FSA's chief executive.

Mr Sants - and his chairman, Lord Turner, also staying on - are widely seen to have raised the FSA's game very considerably since its disastrous performance in the run-up to the market mayhem of 2007-2008.

Even so, Mr Osborne has taken something of a personal risk.

If another financial storm comes over the horizon and the regulators react ineptly because they're fixating on which of them move to the Bank of England and which to the new Consumer Protection Agency, he will be the punchbag.

Osborne's big City moment

Robert Peston | 08:40 UK time, Wednesday, 16 June 2010


George Osborne's first Mansion House speech tonight will arguably be the most important the City has heard since Gordon Brown's debut in 1997.

George OsborneBrown created a super-regulator, the Financial Services Authority, which Mr Osborne will today say is to be broken up.

And Brown transferred responsibility for setting interest rates and controlling inflation in consumer prices to the Bank of England's Monetary Policy Committee - which Mr Osborne will today augment with a Financial Policy Committee at the Bank of England, with powers to ration credit and prevent rampant inflation in assets.

To state the obvious, those New Labour economic reforms of 13 years ago did not prevent us experiencing in 2007-8 the worst banking and financial crisis since the 1930s.

Gordon Brown may have ushered in an era of stability in consumer inflation. But there has been no such stability in asset prices - house prices went through the roof - or in the provision of credit, which at times became too cheap and plentiful for rational decision making by businesses and households.

So here's a recap of the main elements of Mr Osborne's plans to reconstruct what's known as the micro-prudential and macro-prudential architecture - or, to translate, to prevent financial institutions from taking crazy risks and to prevent entire markets from overheating in a way that means that the economy is taking a crazy risk.

As readers of this blog will know, the Financial Services Authority is to be dismantled.

The part that's supposed to prevent banks taking dangerous gambles, which regulates and supervises them, will become a subsidiary or arm of the Bank of England.

And the bits that are supposed to protect consumers and crack down on crooks will be injected respectively into a new Consumer Protection Agency and an Economic Crime Agency.

That brand new Financial Policy Committee at the Bank of England will have the responsibility to maintain financial stability and the power to stop important parts of the economy roaring away in an unsustainable and dangerous way.

So if, for example, house prices were rising too fast, this committee could force banks to provide less credit or less cheap credit in the form of mortgages.

Many of you will doubtless say that most or all of this sounds sensible.

But don't be fooled into thinking that any reform is forever. By definition, all such reforms are combating the last disaster to afflict the economy: they're fighting the last war.

History tells us that our next financial or economic nemesis will be the one we didn't expect, for which Mr Osborne's reforms - however well-calibrated and apt they may seem - are likely to turn out to be utterly useless.

Murdoch's London-based global news hub

Robert Peston | 08:42 UK time, Tuesday, 15 June 2010


"You're not having BSkyB on the cheap."

Sky remote controlThat was the rather stark message that BSkyB's board gave to News Corporation this weekend, when it first offered 675p a share to buy the 61% of the company that it doesn't already own and then increased the offer to 700p - which would value the whole of Sky at £12.2bn.

BSkyB's board and its advisers believe the business is worth around £1bn more, or greater than 800p per share.

So what happens, now that BSkyB has rebuffed the initial bids?

Well, News Corporation will press ahead with the process of trying to buy Sky by initiating the process of having the European competition regulator scrutinise the deal.

One interesting question is whether British regulators, the Office of Fair Trading and Ofcom, and the British government will want to repatriate scrutiny of the deal, as they have the right to do.

Some may think David Cameron, the prime minister, will want to be a million miles from any adjudication on Sky's commercial ambitions, given that he was perceived to have benefited greatly during the general election campaign from the enthusiastic support he received from Rupert Murdoch's Sun newspaper.

But his Liberal Democrat partners, who have traditionally been critics of the media clout of Mr Murdoch, will be in something of a quandary.

Because they'll be aware that in media deals of this size and importance, the government has the right to intervene on public interest grounds.

Vince Cable, the business secretary, will probably not wish to be seen to be wimping out of having a voice on a takeover that would profoundly change the media landscape in the UK.

The takeover would erase any scintilla of doubt that Mr Murdoch's News Corporation would be the most powerful of all the traditional media groups in the UK. Only Google would perhaps be as influential.

The combination of Sky with his newspapers, such as the Sun and the Sunday Times, would generate annual revenues of around £8bn, compared with the £4.6bn income of the next largest player, the BBC.

For me, the fascinating aspect of it all would be in the news arena.

It would put Sky News together with Mr Murdoch's newspapers and - very importantly - his new venture in putting their online versions behind a so-called pay wall.

The opportunities for cross-promoting those newspapers on Sky will be seen by other newspaper groups as giving News Corporation a huge advantage.

And in a world where digital convergence is a reality, not blue-sky waffle, they'll also be fearful of the potential of marrying Sky's pay-TV platform with News Corporation's pay-for-news platform.

As for James Murdoch, the heir apparent to Rupert Murdoch, he would sit in the middle of a unique media hub located in London.

He would become arguably the single most powerful figure in European media, huge in pay TV - in the UK and Italy - and massive in news.

Update 11:30: The likelihood must be that eventually News Corporation and BSkyB will agree a price for the 61% of Sky that News Corporation doesn't yet own.

The tone of their statements this morning suggests an intent to marry.

More interesting therefore will be the attitude of regulators and politicians.

As it happens, British regulators - Ofcom and the OFT - already treat Sky as effectively controlled by News Corporation.

That's absolutely clear from their regulatory actions over the past few years.

So in theory the change to 100% ownership would not represent a hugely significant event for them.

But that's to ignore one important consequence of the deal: News Corporation would be able to get its mits on Sky's £1bn plus of annual EBITDA cash flow.

At a time of severe financial difficulties for most newspaper groups, access to all that cash would reinforce the market strength of News Corporation's formidable array of titles - notably the Sun, the Sunday Times, the Times and the News of the World.

Arguably therefore the competitive landscape in news would tilt further to the benefit of the Murdochs.

Maybe that won't be significant enough to worry regulators either in Brussels or the UK.

But, as I mentioned earlier, it will alarm some politicians - including those Lib Dems, now members of the government, who were horrified by how the Sun lampooned Nick Clegg in the closing stages of the election campaign (before Mr Clegg became the best chum of D Cameron, the Sun's preferred candidate to head the government).

FSA break-up: What happens if eurozone implodes?

Robert Peston | 13:41 UK time, Monday, 14 June 2010


Following my disclosure yesterday that George Osborne will announce on Wednesday that he's pressing ahead with the break-up of the Financial Services Authority, here are a few more relevant details and a couple of additional questions.

FSA building

To begin at the beginning, the FSA was created in 1997 to be one of the world's first truly integrated regulators.

The word to focus on is "integrated", which means that breaking it up won't be quick or easy.

The FSA's conduct-of-business operations, which the coalition government wishes to hive off into a new independent Consumer Protection Agency, are thoroughly enmeshed with financial supervision and regulation activities, which would be transferred to the Bank of England.

Or to put it another way, before the supervision/regulation arm of the FSA can become a subsidiary of the Bank of England, the FSA actually has to create supervision/regulation as a discreet entity.

That will entail complex personnel negotiations and decisions, plus tricky judgements about where the line between supervision/regulation and conduct-of-business actually lies.

Also both the Bank of England and the FSA have slightly odd legal structures: they operate independently from government; they fund themselves; they provide public services; and neither is a classic nationalised entity.

So turning an important part of the FSA into a subsidiary of the Bank is probably easier said than done.

In any event, there is little possibility of the Bank of England being able to complete the takeover of supervision/regulation in less than two years.

So the FSA will be with us for a while longer, with all its employees knowing that they will be transferred to another organisation - but not quite knowing, for a period, when and where they will be going.

Managing this transition will be tricky. There'll be the kind of atmosphere of uncertainty that may persuade the better FSA executives to quit.

Remember that the FSA's existing chief executive, Hector Sants, has already announced his departure.

And only last week Sally Dewar, the director in charge of risk, said she'd be off.

Who'll be the new chief executive? There must be a good chance that Dewar's peer in charge of supervision, Jon Pain, will fill the role, at least on an interim basis.

But there'll be a significant burden placed on the chairman, Lord Turner, to prevent the FSA imploding in the last two year's of its existence.

Which brings me to the two material points.

First, most dispassionate observers would say that the FSA has improved its performance since 2008.

You may say they couldn't have done any worse in the few years leading up to 2007-8, when we experienced the worst banking crisis since the 1930's.

That said, there is evidence that the FSA today is fulfilling its core functions of preventing banks and financial intuitions from taking crazy risks and also biffing cowboys and crooks much better than it was.

So if it is already back from being bust, why fix it?

More germanely, and as readers of this column will know only two well, we are living through a renewed period of stress in financial markets.

The risks have risen of a second wave of banking disasters, this wave caused by the repayment difficulties faced by certain over-stretched eurozone governments.

Which is why this may not be an ideal moment for the FSA's senior executives to concentrate on internal reorganisation rather than preventing collateral damage to British banks and insurers?

None of which is to argue that Mr Osborne is wrong to see benefits in giving the Bank of England overall responsibility both for maintaining the stability of the financial system and making sure individual financial institutions don't collapse and undermine that stability.

And he may also be right that by combining consumer protection and financial supervision/regulation within a single organisation, the FSA may have been doomed never to do either in an optimal way.

So the issue is probably not the logic of his reforms but the timing of them.

To which I presume he would say that if an important reform is worth doing, then there are significant dangers in delay.

Which is why I assume that the chancellor will push the FSA to behave as a subsidiary of the Bank somewhat before it actually becomes a subsidiary of the Bank.

Finally, and at the risk of boring you, I should add that there are other legal and management challenges of a highly demanding sort that flow from the FSA break-up.

It won't be speedy to crunch the consumer-facing bits of the FSA with the part of the Office of Fair Trading that regulates consumer credit and thus create a Consumer Protection Agency.

Nor will it be a walk in the park to establish a new Economic Crime Agency - because that will entail the merger of the FSA's arm that investigates and prosecutes financial crime with the Serious Fraud Office and with relevant parts of the Fraud Prosecution Service, Revenue and Customs and the OFT.

Or to put it another way, no one should doubt the scale of Mr Osborne's ambition to reinvent financial regulation, crime investigation and consumer protection.

Where he may face criticism is whether - with the financial system still so fragile - this is the best possible moment to distract regulators from their fairly important day-jobs.

FSA to become Bank of England subsidiary

Robert Peston | 16:49 UK time, Sunday, 13 June 2010


Reports that the coalition government is backing away from the abolition of the Financial Services Authority as an independent financial regulator seem to be premature.

My understanding is that the part of the FSA that monitors banks, insurers and other financial institutions to prevent them taking excessive risks will become a formal subsidiary of the Bank of England.

I expect this to be announced by the Chancellor, George Osborne, in his first Mansion House speech on Wednesday evening.

In other words the Bank of England would have ultimate responsibility for banking regulation and supervision as the "owner" of the reconstructed and slimmed-down FSA. But the financial regulator would retain its own board and - to an extent - its own identity.

This transfer of responsibilities to the Bank of England would represent a symbolic and substantial reversal of one of Gordon Brown's first acts as chancellor in 1997, when he removed banking supervision from the Bank of England and merged it with other City regulatory bodies to create the FSA.

That said, my impression is that Mr Osborne is trying to preserve a semblance of independence for the FSA by putting its financial regulatory activities into a legally separate subsidiary of the Bank of England, rather than into just another operating division of the Bank.

Within the Bank of England, a new Financial Policy Committee would also be created, consisting of Bank executives with a direct responsibility for financial stability and senior representatives from the FSA.

This Financial Policy Committee's primary duty would be to maintain financial stability, or avoid the kind of crisis we experienced in 2007 and 2008 when bank after bank went to the brink of collapse and we came close to the meltdown of the financial system.

The committee would have a set of so-called "macro-prudential tools" to deter banks from providing credit when there are signs that the economy or parts of it - such as the housing market - are overheating.

It would also have the new financial supervision subsidiary of the Bank of England under its sway. And it would expect to be the ultimate decision making body for regulatory decisions affecting the activities of the biggest banks and insurance companies.

So, for example, if a big bank wanted to buy another big bank, the Financial Policy Committee would determine whether that should be allowed or whether it should be sanctioned only subject to conditions designed to minimise the risks of the deal.

The ambition would be to avoid a repetition of the kind of regulatory disaster that occurred in 2007, when Royal Bank of Scotland was permitted by the FSA to buy the rump of the giant Dutch bank ABN Amro, and did so in a way that made the enlarged bank too dependent on unreliable wholesale finance and slashed the amount of capital RBS was holding relative to assets as a buffer against losses.

That takeover by RBS was the primary reason why RBS had to be rescued by taxpayers in Britain's biggest ever financial bailout in the autumn of 2008.

George Osborne has long been critical of the tripartite regulatory system imposed by the previous government, in which oversight of the financial system was shared between the FSA, the Bank of England and the Treasury.

Osborne and other critics of the tripartite system argued that it was cumbersome and meant that in practice no one could be held sufficiently accountable when a big bank (or in practice, a whole series of banks) ran into difficulties.

Under Osborne's proposed reforms, the buck will very firmly stop with the Bank of England. The Bank of England will be to blame if there's another banking calamity that tips the UK back into recession.

Now you may think that none of this is news - in that these reforms are very much in the spirit of the regulatory changes Osborne proposed when shadow chancellor.

But ever since the coalition government was created last month, it has become widely believed in the City that Mr Osborne had dropped his previously announced commitment to "abolish the FSA" (which was the phrase used in a Tory policy document, "Change for the Better in Financial Services", published in April).

The supposed evidence that Mr Osborne had dropped his determination to dismantle the FSA was that the Tories' coalition agreement with the LibDems made no mention of plans for the FSA at all. Instead, all that document said was that "we will bring forward proposals to give the Bank of England control of macro-prudential regulation and oversight of micro-prudential regulation."

That vague formulation, "oversight" of micro-prudential regulation, suggested that the FSA might be preserved to a large extent.

But in the end, Mr Osborne has taken the view that there needs to be a cultural revolution to toughen up the supervision of banks and other financial institutions - which can only be achieved by separating that activity from consumer protection and also by putting the Bank of England into the driving seat.

Anyway, enough of the hermeneutics.

Related reforms likely to be announced by Osborne are the separation of the FSA's consumer protection operations into a new Consumer Protection Agency and of its enforcement activities into a new Economic Crime Agency.

However there are plenty of unanswered questions. These include:

1) Will Osborne set up the new operating arrangements for the Bank of England and FSA in shadow form, so that the system is working in an informal sense relatively quickly prior to the necessary legislation going through parliament?

2) What will be the relationship between Paul Tucker, the deputy governor of the Bank of England in charge of financial stability, and the new regulatory subsidiary of the Bank of England?

3) And, is it remotely possible that one big beast in the financial policy jungle, Lord Turner, chairman of the FSA, would agree to be answerable to another big beast, Mervyn King, governor of the Bank of England?

Mervyn King as Adair Turner's boss? Hmmm. That doesn't sound like a sustainable or even plausible relationship.

BP dividend suspension: Not whether, but when

Robert Peston | 16:45 UK time, Friday, 11 June 2010


BP's directors will discuss whether to suspend dividend payments at a meeting on Monday, although in an informal sense the decision to make some kind of dividend reduction has already been taken.

In practice, Monday's discussion at newly instituted weekly meetings of the board will be about when to suspend the payments, how long to suspend the payments, and what to do with the billions of dollars that would be saved and not paid to shareholders.

As I've been saying for a couple of days, it looks increasingly likely that dividend payments will be ceased for a period - because of the intense pressure to do so from senior US politicians and the White House.

That said, no formal announcement on the dividend is expected to be made on Monday.

Instead the BP board will prepare the ground for negotiations on what it should and can do about the dividend that are expected to take place on Wednesday with President Obama and other senior members of his team.

"There's no point announcing what we'll do about the dividend until we've heard the view of the administration on this", said a senior BP source.

BP's chairman, Carl-Henric Svanberg, will lead the BP delegation at the meeting, but the chief executive, Tony Hayward, and the executive in charge of the company's response to the rig disaster, Bob Dudley, will also be present.

Update 1715: There's no point making an implacable enemy of the most powerful man on earth.

Obvious to most of us, I suppose.

But it has taken a while for BP's board to reach the decision that if President Obama wants them to stop paying dividends, then for a while at least they'd better do so.

That said the when, how and how long of suspending dividend payments won't be fixed till a board discussion on Monday, followed by negotiation with the president himself on Wednesday.

Even so, it is certain that BP will cease paying the £1.8bn of dividends per quarter that it's been delivering to shareholders - until it can quantify the final massive bill for the Gulf of Mexico oil debacle and prove to the White House that it can afford those enormous costs.

Even if those costs of clearing up the mess, fines and compensation exceed £20bn, as analysts expect, BP feels it has the resources to cope.

Its biggest fear, which its chairman will express to the president, is that the US administration's campaign against it could throw the baby out with the oily bathwater - in that a bankrupt BP would leave the president with no-one to clean up America's worst-ever environmental disaster.

Update 2019: For what it's worth, a BP spokesman tells me that he doesn't expect any announcement on the dividend next week - which is not what I was being told by BP sources earlier.

The official position is as follows.

The board will discuss the dividend on Monday. And it will discuss the dividend with President Obama on Wednesday.

But the company does not expect to make any statement on the dividend next week.

And as of now, the board does not expect to make a formal decision on the dividend until nearer the time of its quarterly results in July.

We'll see what happens next week.

Reckless banks and BP: What they have in common

Robert Peston | 09:20 UK time, Friday, 11 June 2010


The Deepwater Horizon oil rig was operated by Transocean.

It was cemented by Halliburton.

BP deep water oil rigAnd an important element in the safety equipment that failed was manufactured by Cameron International.

So, why oh why, BP shareholders ask me, is the US administration apparently heaping all the blame for the devastating oil spill in the Gulf of Mexico on BP?

The answer is not hard to find.

The overwhelming financial benefit from the operation of the rig accrued to BP and its shareholders.

And the company that books the profits in the good times has to absorb the losses when it all goes horribly wrong.

The simple devastating charge that can be laid at BP's door is that it had no timely and viable plan to deal with a high impact, low probability event, viz the catastrophic successive failures of preventative equipment on the rig itself.

It is precisely the same charge that was levelled at big financial institutions from Northern Rock, to Royal Bank of Scotland, Lehman, AIG, UBS, Citigroup and the rest - namely that they had no plan B for when the unthinkable happened and entire financial markets, on which they were dependent for vital finance, closed down.

The analogy can be extended. Because it is quite clear that the long-term costs of finance for banks and therefore for the rest of us is on a pronounced rising trend (ignoring the short-term reductions in interest rates engineered by central banks) as a result of reforms to reduce the risks taken by banks.

And the cost of oil will also have to rise, as companies are forced to take much more expensive precautions when drilling for oil in treacherous regions.

More expensive oil and more expensive finance: it's not a recipe for booming economies, even if both are essential to deliver more sustainable growth.

Carl-Henric SvanbergOn a more parochial issue, I am increasingly hearing grumblings of discontent from shareholders and politicians about the performance - or should that be lack of performance? - of BP's chairman, Carl-Henric Svanberg.

Their point is that at a time of life-or-death crisis for a company, the chairman should become the public face of the business, representing the company to the wider world and taking the lead in meeting with politicians, regulators and shareholders.


Well the priority for the chief executive in these circumstances - especially one like Tony Hayward who was explicitly chosen by BP's board precisely because he was a nitty gritty geologist and professional manager rather than a PR wiz - is to sort the underlying physical problem (the leak), in circumstances of quite extreme personal pressure.

For the chief executive also to be the public face of the business requires superhuman qualities that arguably no business leader possesses. And it's worse for Tony Hayward because he'll be aware that the buck stops with him for the fact that BP didn't have that contingency plan in place for dealing with this catastrophically high impact, low probability event.

What's more, the chairman is supposed to represent all interested parties - the executives, the other employees, shareholders, customers, and so on - in a way that is much harder for any chief executive, even in the good times.

To put it in the starkest terms, any chief executive will always be seen as having too much of his own skin in the game to be dispassionate at a time when the survival of the company is not guaranteed - and therefore everything he or she says will be seen as tendentious to an extent.

Which is why, as one investor put it to me, chairman Svanberg needs to emerge from the wings to the front of the stage, even if the audience seems somewhat hostile.

Update 10.55: The value of BP's brand has probably been seriously impaired by the Gulf Coast debacle. So perhaps it should revert to its previous corporate moniker.

Except that I am reminded by Terry Smith of Tullett Prebon that BP's last uncarnation, till 1954, was as the Anglo-Iranian Oil Company.

Even now, I suspect "Iran" sells less well in the US than "BP" - or at least BP's owners must fervently hope that's the case.

BP's financial pain is America's pain

Robert Peston | 09:48 UK time, Thursday, 10 June 2010

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BP is having as much difficulty steadying its share price as it was having - until the last day or two - in stemming the flow of black stuff into the blue of the Gulf of Mexico.

Gulf of MexicoHaving plummeted overnight on Wall Street, BP shares fell more than 10% in early trading in London - though they've since rallied a bit and are now down 6%.

That 10% fall wiped another £8bn off its market value - and meant that its shareholders were some 47% poorer since the explosion in April on the Deepwater Horizon rig.

By the way, if you're a Brit saving for a pension, you're probably, indirectly, a BP owner. So as Boris Johnson, the Mayor of London, implied this morning on the Today programme, you should probably be alarmed that President Obama has been knocking your company about the head.

What I find extraordinary is that BP's bonds, due for repayment in 2013, were trading yesterday at prices of less than 90 cents in the dollar. In other words, investors were regarding them as junk bonds, with a measurable risk of default.

That must be bonkers, surely?

And although there has already been considerable damage to the wealth of current and future British pensioners, the harm to the US economy may also be considerable.

Some 39% of its shares are held in the US, with some 14% by US individuals.

I'm not sure how happy they'll be that every time the US president lays into BP, they find themselves a bit poorer.

And then there's the issue of the changed perceptions of the costs of drilling in the US basin. With the financial damage from the Deepwater Horizon debacle looking so vast and uncontainable, will investors in Exxon or Chevron or Shell be happy if they develop new deep-water wells, even if the moratorium on such drilling is lifted?

Arguably the ferocious attack by the US administration on BP shows that the risks aren't worth the rewards. Which could have serious and damaging ramifications for America's indigenous energy reserves.

To put it another way, these problems at BP aren't a little local difficulty for a sizeable company. They could have macro-economic consequences.

That said, as BP itself said in an emergency statement this morning, with the oil price at $74 or so per barrel, it is generating colossal amounts of cash over and above what it needs to cover overheads and invest.

So BP has the money to deal with the financial consequences of the leak, even the White House's latest bill - which is that BP should pay the wages of oil workers thrown out of work by other companies as a result of the suspension of deep-water drilling.

That said, if there were serious damage to the Florida coastline, and that in turn damaged its massive tourist industry, and if BP were held liable for those costs - well, then I suppose we might be into the territory of unbearable financial pressures.

But let's assume for now that the Florida Armageddon is a remote possibility.

On that basis, even if the eventual bill for the Gulf clear-up - including fines and compensation - reached well over £20bn (which this blog has been suggesting looks likely), those costs will accrue only over many years.

Or to put it another way, BP's board is in little doubt that - as of now and in a financial sense - it can afford annual dividend payments that were $10.5bn (or more than £7bn) last year.

But there is another way of looking at the affordability of the dividend - which is in respect of the cost of paying it in collateral damage to its important relationships with the White House and American legislators.

Overnight, the US Justice department said it was examining ways of forcing BP to suspend its dividend until BP's full liability for the oil spill is known with more precision.

And the Justice department is only doing what influential US politicians are demanding. Which is a serious concern to BP, in that it may be a British company by dint of history and legal domicile, but it is very American by virtue of its giant acquisitions of a decade or so ago.

My conversations with those at the top of BP indicate that they're increasingly minded to go for a voluntary moratorium on dividend payments, to bring some kind of fragile truce to hostilities with the US government.

But President Obama should be aware that such a suspension of dividends would in effect deprive US savers of some $4bn of income per annum. Or to put it another way, in a world of global capitalism, Obama can't punish BP and expect all or even most of the pain to be felt in Britain.

Which governments face biggest market risks?

Robert Peston | 12:45 UK time, Wednesday, 9 June 2010


As I think we should all know by now, any borrower - a bank, a business, a government, you or me - faces two interconnected risks.

There's a solvency risk: the risk that we become incapable of honouring our debts in full, perhaps because we've borrowed too much in the first place or because we'll suffer some blow to our ability to generate income.

And then there's a liquidity risk, which is the risk that we run out of cash at a vital moment, often because our creditors lose confidence in our ability to pay our bills, and therefore stop lending to us just when we need their credit most.

Because liquidity or cash often dries up when lenders becoming fearful that we're on the brink of insolvency, and thus deprive us of further credit, solvency and liquidity are intimately related.

Lehman building, New YorkThe great banking crisis of 2007 to 2008 was a story of solvency fears generating a liquidity freeze - which in turn bankrupted Lehman Bros and would have killed off Northern Rock, Royal Bank of Scotland, HBOS and other big banks around the world had they not been rescued by taxpayers.

Governments, taxpayers and central banks stepped in to provide vital funds to most western banks that markets were not providing, so the liquidity risk for banks dissipated - for a while at least.

As I've banged on about for some time, the scale of such state support for the banking sector was unprecedented and mind-boggling, equivalent to some 25% of global GDP at the peak, or £1,000 for every person on the planet.

But there is a circularity here: governments and central banks can only provide the liquidity required by the banking system for as long as they can borrow what they need from markets by selling government bills and bonds; so perceptions of countries' solvency matter not only to their own liquidity but also to their ability to guarantee the liquidity of the financial system.

Greek flagWhich is why fears about the solvency of Greece and other overstretched eurozone countries have immediate knock-on effects on investors' and creditors' confidence in the credit-worthiness of banks that have lent to such countries and - even if only indirectly via the European Central Bank - have borrowed from such countries.

Thus the reasonable perception by US money-market funds that the risk of providing credit to eurozone banks has increased was in part responsible for the doubling in the interest rate at which banks were able to borrow dollars from other financial institutions, the BBA three-month dollar Libor rate.

But what of the liquidity risks faced by governments themselves, the risk that investors will stop providing the credit they need?

Well that's a function both of the gap between their revenues and their spending, which determines how much new money they have to borrow, and also how much of their existing debt is due for repayment in the next year or two.

For obvious reasons, investors' primary attention is focused on that gap between revenues and spending, the public-sector deficit, because insolvency is the inevitable consequence of a national debt that becomes too large to service.

This is not some theoretical, academic risk. A quarterly poll published today by Bloomberg of investors and analysts shows that 73% of them believe that Greece will default on its debts - in spite of the ambitious rescue package provided by other eurozone states and the IMF.

Now one of the reasons Greece has been so vulnerable is not just that it has been living beyond its perceived means, but also that in 2011 and 2012 huge amounts of its older debts come up for repayment.

In 2011 and 2012, it has to repay 63bn euros, equivalent to more than a quarter of its GDP. The only way to do that would be to sell new bonds to investors - impossible when creditors fear the country is going bust.

Euro symbolSo the imminence of the repayment date of that 63bn euros of debt turned a Greek problem into a Greek crisis. The only solution was for the eurozone and the IMF to provide 110bn euros of credit to the Greeks that the markets would not supply.

In other words, the proximity of repayment dates on over-stretched countries' older debts matters enormously to judging the probability of whether those countries are able to reduce their deficits in an orderly way or whether there's likely to be a disorderly and painful crisis.

Or to put it another way, even if - like the UK - a country is viewed as borrowing far too much, it has a better chance of putting its financial house in order so long as a manageable amount of its older debts are not about to mature: the risk of a liquidity crisis is commensurately lower, the further out are the repayment dates on what it has already borrowed.

Which brings me, in my characteristically meandering way, to some fascinating data supplied to me by Moody's and Bloomberg (to which I am grateful).

These are statistics on how much existing debt has to be repaid in 2010, 2011, 2012 and 2013 by a series of countries perceived to have borrowed more than is prudent.

I have converted these raw numbers into a percentage of the respective states' GDPs, to allow comparability and to give a more meaningful sense of the refinancing challenge these states face.

Now, what may steady the nerves of some of you is that the UK faces comparatively modest debt repayments (as opposed to new borrowing) between 2011 and 2013: at the peak in 2012, it has to refinance bonds equivalent to 3.9% of GDP.

So the UK's total financing requirement over the next few years should not exceed 15% of GDP. It was considerably higher last year, in fact.

Which is not to say that the UK's public sector deficit, equivalent to 11% of GDP, is a trivial problem. But the government has perhaps a bit longer than would otherwise be the case to reduce that deficit because it has relatively less existing debt to refinance than some other countries.

Or to put it another way, because the UK's peak financing requirements is less than that faced by other countries, the UK is perhaps less at the mercy of markets than some may fear.

So what are these maximum financing requirements of countries regarded as overstretched?

Well, I've taken the annual average for a country's deficit over the period 2009 to 2011 (as per the IMF's figures) and then added the maximum repayment in a single year faced by that country.

What this should show is the vulnerability to investors losing their appetite to lend - and should also identify the year of greatest susceptibility to a liquidity crisis.

The results are perhaps not quite what you would expect.

Within the European Union, Greece (predictably) comes top of the list for annual financing requirement - with the need to raise 23.2% of GDP in 2012.

Second place however may surprise you: it's Belgium, with a 19.3% financing requirement this year.

Third is Spain, with the need to raise debt equivalent to 19.2% of GDP in 2011.

Fourth: France, an 18.9 financing requirement per cent this year, because debt equivalent to 11.2% of GDP is due for repayment.

Fifth: Italy, with a refinancing requirement of 18.8% of GDP this year and not much less next year.

Sixth: Portugal, whose peak refinancing requirement would be 18.6% (in 2011).

Germany looks pretty sound on this measure, with a peak financing requirement of 15.4% next year.

But here's what I thought was extraordinary. Ireland, despite its huge current deficit, has a peak financing requirement of 14.3%, because so little of its existing debt is coming up for repayment.

Broadly, these results support the conclusion that Portugal, Italy and Spain face the greatest financing challenge, because their current deficits are so substantial (the pure solvency risk is greatest for them).

But neither Belgium or France can be complacent about the need to maintain the confidence of creditors.

Also, perhaps to state the obvious, the next 18 months is the period of maximum risk of a eurozone funding meltdown.

Finally, a bit of global context is probably helpful.

As it happens, on my methodology, the peak financing requirement of the US, at 25% of GDP this year, is greater than even that of Greece.

But the US appears to be able to raise these colossal sums with ease, for the paradoxical reason that investors see it as a relatively safe haven at a time when they've become anxious about the eurozone.

That said, the US cannot borrow on this scale forever.

As for Japan, well its financing requirements defy belief, peaking at 50% of GDP this year and 34% next year.

But there is that crucial structural difference between Japan and Europe which allows the Japanese government to borrow these astonishing sums: Japanese individuals save far more than we do, and lend their money to the state.

It's moot whether Japanese savers will go on lending such massive amounts to their government forever. But right now the Japanese government can worry rather less than the British government does about how international investors and financial institutions view its credit.

Leahy's exit: A big event

Robert Peston | 11:02 UK time, Tuesday, 8 June 2010


Terry Leahy would be identified by most of his peers as the outstanding British public-company boss of his generation.

Terry LeahyIn his 14 years as chief executive of Tesco, and in his previous post as marketing director of the supermarket group, he - more than any other executive - was responsible for giving Tesco an apparently unassailable lead over competitors.

Today it may seem incredible that Tesco lagged well behind Sainsbury's some 20 years ago.

But Leahy and his predecessor, Ian Maclaurin, had the simple but devastating insight that Sainsbury had become too fixated on widening profit margins, and not sufficiently committed to minimising prices for customers.

Tesco aimed to maximise sales by creating an image of offering better value - "every little helps" as it repeated incessantly - and combined that with a far-sighted commercial policy of buying up as much development property as possible.

The result delighted Tesco's owners - with strong growth in sales, which of course meant that it wasn't long before it massively outstripped Sainsbury in respect of profit too.

In the process, of course, "Tescopoly" was also born - or the charge that the spread of Tesco outlets of all sizes all over the country was wreaking havoc to small shops, the traditional high street and the environment.

Leahy did not ignore the allegations. And took steps to reduce Tesco's carbon footprint - even while consistently claiming that it was misplaced to criticise Tesco for delivering what its millions of customers so obviously wanted.

For him, however, the rise to dominance in the UK was only a small part of the story.

The company was also unusual for a retailer and for a British outfit in successfully managing a huge expansion across the globe, from Eastern Europe, to Asia to North America.

And if there is something of a puzzle about the timing of his departure, it is that Tesco's establishment of an operation in the US - its Fresh 'n' Easy chain - is work in progress and remains a long way from profit.

Since Fresh 'n' Easy was widely seen as a personal initiative by Leahy, some may feel his exit is premature.

Even so, when he goes next year he'll have run this enormous show for some 15 years - much longer than is the norm for British public companies.

What will he do next? Well he says he wants to concentrate on private investment - which seems curiously unambitious for an intensely driven man.

The previous government made a number of attempts to enlist him to help improve the efficiency of the public sector.

It would be odd if the new coalition didn't woo him too - since a touch of Tesco productivity in certain state services would probably be no bad thing at a time when money is rather tighter for the Treasury than it is for Tesco.

He said this morning however that he had no wish to go into politics. Which was not quite a "no, nay, never" - though my personal experience of him is that he can be an immovable object, so it is possible that he will opt for anonymous retirement.

No more money

Robert Peston | 09:15 UK time, Monday, 7 June 2010


They're certainly united in telling us we're all going to be poorer for some time to come.

Robert PestonLast week Vince Cable pointed to households' record and arguably excessive debts (equivalent to 170% or so of disposable income) to explain why consumer spending can no longer be the engine of our economy.

Which is why as business secretary he is to an extent picking up where his predecessor, Lord Mandelson, left off, by arguing for industrial interventionism, or the use of scarce government resources to help exports and exporters (though not, he insists, through some kind of government-sponsored Britain's Got Talent for manufacturers).

As for David Cameron, he is today shutting down the other engine of economic growth, the public sector: a state that grew and grew and grew under New Labour is set to shrink and shrink and shrink, says the prime minister.


Yes, for the state as for the individual, frugality is necessitated by past profligacy - whose disturbing manifestation is the national debt rising by an unsustainable 11% of GDP per annum.

So debt is our problem. And its effects have been particularly painful for younger people.

Robert PestonWhich is why I have made a new programme for BBC3 - On the Money, tonight at 1900 BST, clips here and here. It looks at some - by no means all - of the causes and triggers of this mess and discusses the implications with an audience of those at the start of their careers.

Some would say they have every right to be furious with my older generation - since it is plausible to say that the parents of today's young adults had more than their (our) fair share.

The argument would be that we undermined the foundations of the economy by borrowing more than we could afford - and it is our children who have born the brunt of rising unemployment.

And, if you see rising public sector debt as an inter-generational transfer of a future tax bill or reduced public services, it is younger people who will pay for the more generous state provision we've enjoyed.

And that's to ignore the prospectively massive burden for our kids of funding our pensions.

The insult added to injury is that all that household borrowing led to a trebling of house prices over the 10 years to 2008's peak - but the subsequent fall of 16% doesn't even begin to make homes affordable for first-time buyers.

Here's the funny thing. Those in our audience for On the Money weren't on their way to the barricades, as far I could tell.

They were strikingly optimistic about their personal prospects - and primarily interested in practical solutions to their immediate problems (such as how to avoid being classified as a poor credit risk - yes they want to borrow more).

One of the conclusions I drew was that the general-election campaign had not prepared them in any serious way for the public spending cuts and lean years to come.

So as and when the harsh reality of today's speech by David Cameron sinks in, the anger of youth that is conspicuous by its absence may be ignited (oh, and that pernicious disillusionment with our elected representatives - which is particularly characteristic of a younger generation - is probably not going to evaporate).

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Will Thiam survive at Pru?

Robert Peston | 13:04 UK time, Thursday, 3 June 2010

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The balance of probability is now that Tidjane Thiam will not be ousted as chief executive of the Prudential, even though he has suffered the unusually sharp humiliation of being frustrated by his own shareholders from carrying out a takeover that would have transformed his company.

Tidjane ThiamHere is why it is likely - though not inevitable - he will survive (for a dignified period at least) the buffeting from some disgruntled investors.

1) The non-executives on his board are solidly behind him - or at least that is my understanding from conversations with them.

2) Most of those shareholders opposed to the takeover of AIA, the substantial Asian insurer, were unhappy about the $35.5bn price, rather than the strategic rationale for the deal.

3) Ten of the Pru's top 12 shareholders told the company on Monday that they would back the $30bn revised price that Thiam thought he had negotiated with AIA's owner, AIG.

4) The collapse of the deal leaves AIA and its employees unsure of their future, after many weeks of believing (with reluctance) that the Pru would be the new owner and employer. Which may deliver a competitive advantage to the Pru's existing and fast-growing Asian operation.

5) The Pru now knows more-or-less everything it is possible to know about AIA, thanks to the due diligence process it conducted during the takeover attempt - which again should hand the Pru some kind of competitive advantage. Those valuable industrial secrets may or may not be worth the £450m the Pru has shelled out in pursuing AIA, but they are worth something.

6) AIG, the parent of AIA, has just manifested potentially destabilising divisions at its apex - with its chief executive, Robert Benmosche, having agreed to sell AIA to the Pru at the lower $30bn price, but being outvoted by his board. Also, it seems that the US Treasury, the rescuer of AIG during the markets meltdown of 2008, would also have preferred the cut-price sale to have gone through. Again, such division between those responsible for the governance of an important global rival is worth something to the Pru.

7) Some investors would argue that if a Pru board member has to walk the plank, it should perhaps be the chairman Harvey McGrath, who should take that short stroll to oblivion. Most investors would probably prefer to have an ambitious chief executive at the helm, but would look to a chairman to rein in ambitions that look dangerously expensive.

8) Many Pru shareholders, when arguing against the AIA takeover, did so because they liked the Pru's existing mix of businesses - in the UK, US and fast-growing Asia - and their recent performance. So if investors are being logical (which can't be taken for granted) they would stand by the team that has been delivering that performance.

None of which is to say that Thiam hasn't been damaged by the debacle - but simply raises the possibility that the wounds may not be mortal.

Big is ugly (in a corporate sense)

Robert Peston | 21:00 UK time, Tuesday, 1 June 2010


The collapse of the Pru's attempt to buy AIA of Asia for more than £24bn is an important event in the history of British stock-market capitalism.

Prudential logoIt shows that conventional investment institutions are prepared to act more like the independent owners of a business and not as absentee landlords too readily compliant with the wishes of managers - which is how their critics would characterise them.

In this rare case, it was the Pru's own shareholders who frustrated the takeover - by making it clear that they thought the purchase price was too steep and by telling the Pru's directors that they would vote down the deal.

The implications are significant.

The Pru's chief executive and chairman may have to resign, having wasted hundreds of millions of pounds of shareholders' money on a deal that won't happen.

But perhaps more importantly, it shows that investors have become much less supportive than they were of companies that want to become global giants through takeovers - since gigantism has often led to monstrous blunders.

After the woes of those enormous banks - from Citigroup to Royal Bank of Scotland - and the current humiliation of bid-bloated BP, it's not surprising that shareholders now see big not as beautiful but as grotesquely, dangerously ugly.

What investors have learned is that there are limits to the benefits of geographic and product diversification.

When a company becomes bigger and less reliant on a limited number of products, services or customers, there is reduction in the risk of serious setbacks up to the point where human ingenuity and information technology can actually monitor the risks being run by said company.

What we've learned in the last three years is that a number of massive global businesses - especially but not exclusively in the banking sector - grew well beyond the limits were any mortal could have a proper grasp of what was going on in the myriad nooks and crannies of those businesses.

Which is why, as the Pru's management have learned the hard way, investors have become much more wary of companies that want to carry out mega, "transformational" takeovers.

Will BP be forced out of the US?

Robert Peston | 15:39 UK time, Tuesday, 1 June 2010


There's another £13bn off BP's market value today, taking the cumulative loss since the company sprung its hideous leak to well over £40bn.
Crews work on origin of oil spill near Louisiana coastGiven that BP is a core holding of most British pension funds, that's tens of billions of pounds off the wealth of millions of British people saving for a pension.

And with BP dividends representing around 8% of all income going into those pension funds (and a considerably higher proportion of all corporate dividends received by those funds), if BP's oil spill in the Gulf of Mexico causes collateral damage to its dividend-paying capacity, well, many of us will be feeling a bit poorer.

As I've written here before, it's certainly not ludicrous to assume that the final cost for BP of this mess could wipe out at least an entire year's profit (which for the past three years was just over £13bn on average) - once compensation and possible fines have been paid.

Perhaps more damagingly, the debacle is doing considerable harm to the value of its brand in the US - with what looks like every US citizen, from President Obama down, equating BP with the sullying of one of America's most cherished coastlines.

The talk among BP oil executives is that the company's reputation in the US may have been so tarnished that the board will conclude that an orderly withdrawal from America - with the sale of its massive US assets - may be necessary (it's widely thought, for example, that Chevron would be an enthusiastic buyer of those assets).

Were that exit to occur, it would represent one of the great corporate humiliations of all time, a reversal of those mega-bids of Amoco and Arco by BP - when under the sway of Lord Browne - which transformed a division-two British player into one of the global giants only a decade or so ago.

And what of Lord Browne's successor as chief exec, Tony Hayward?

It would be challenging to identify any specific decision or lapse by him as the cause of what is now seen as the worst oil spill in US history.

But some argue that BP was slow in recognising the gravity of the debacle after the explosion in April.

And then there's the boringly obvious point that angry shareholders, angry Gulf coast fisherman and angry US citizens have a very human need to blame someone - and if not the BP boss, then who?

It's difficult to see how Mr Hayward's tenure at BP can extend beyond his immediate management of this remarkable crisis.

The Pru's dead-parrot deal

Robert Peston | 11:05 UK time, Tuesday, 1 June 2010


The Pru's attempted takeover of AIA is dead and buried - which kills off one of the most ambitious attempts to expand overseas by a British company.

Prudential buildingThere's no ambiguity about that.

Once the Pru attempted to negotiate the price down from $35.5bn to a touch over $30bn, to be met with an inflexible "no" from the board of the vendor, AIG, that was it: curtains, finito, fat lady screeching, dead parrot nailed to perch.

The only point that matters is that the Pru's shareholders have been making it clear for some weeks (as you've read in this blog) that they thought the Pru was overpaying to become the market leader in Asia; and there was (and is) no doubt that they would vote the deal down if the price could not be lowered.

The only outstanding issue - a purely technical one - is whether AIG insists that the Pru honours the contract and actually puts the deal to a shareholder vote next Monday.

The Pru thinks that holding such a vote would be a waste of time and money: it knows that the outcome will be a big fat raspberry.

So it's asking AIG to absolve it of the requirement for that particular public humiliation.

But there's still a fair amount of cold sick for the Pru's board to swallow: a compensatory break fee of around £150m will have to be paid to AIG; and then there'll be further fees of several hundred million pounds (to be quantified later today) to be paid to an army of banks, lawyers, public-relations firms and so on, for advice and (the lion's share) for underwriting the takeover finance.

In other words, this has not been a cost-free adventure in the tempestuous seas of the Far East.

Which means that some shareholders will feel that the failure requires those at the top of the Pru to pay a price. There will be pressure for the resignation of the chief executive, Tidjane Thiam, and also for the exit of the chairman, Harvey McGrath.

The Pru is, as we speak, assessing whether this pressure is overwhelming.

Here is what will determine whether the owners feel that Thiam and/or McGrath have to go.

Was their mistake a failure to understand, in a fundamental sense, what the owners wanted, in which case their departure is inevitable?

Or was it a less disastrous misreading of the difference between how Asian assets are valued in Asia and in London? That market misjudgement might (I say might) be survivable.

Because here's the funny thing.

It's impossible to believe that AIG - or in practice the US Treasury Secretary Tim Geithner and the US Treasury (which has had the power to boss AIG since its bailout at the end of 2008) - would have turned down the Pru's reduced price if they weren't confident they could get a better price for AIA elsewhere.

That better price may come from reverting to AIG's plan "A" of floating AIA on Asian stock markets; or it may come from flogging the business to another bidder, possibly a Far Eastern one.

If AIA is ultimately sold elsewhere for not far off the Pru's original $35.5bn offer, it will be harder to argue that Thiam and McGrath made a grotesque, career-destroying boo-boo.

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