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The perilous condition of Portugal's banks

Robert Peston | 15:48 UK time, Tuesday, 30 November 2010


The Portuguese central bank has warned today that Portugal's banks have become too dependent on loans from the European Central Bank and will need to raise significant amounts of new capital to "resist additional adverse shocks".

The analysis of the weakness of Portugal's banks, contained in the Banco de Portugal's Financial Stability Report, is disturbingly similar to the structural flaws in Ireland's banks, which took Ireland to the brink of bankruptcy.

There is however one important difference, which some will argue makes Portugal's financial predicament more perilous: Portugal's banks have not only been borrowing colossal sums from the ECB, they have also been lending billions of euros to the Portuguese government, so that it can finance the significant gap between what it spends and its dwindling tax revenues.

This is how the central bank put it: "the expansion of Portuguese banks' balance sheets in the first half of the year essentially reflected the financing of general government".

That implies Portuguese banks lent between €11bn and €13bn to the Portuguese government in the first six months of 2010, based on statistics published by the central bank.

Over the same period, Portuguese banks found it almost impossible to borrow from commercial sources, from other banks and financial institutions. So they avoided insolvency by using two techniques, neither of which is sustainable over the long term.

They borrowed from what the central bank calls "institutions belonging to the perimeter of the respective banking groups" by selling bonds to them - which is in effect shuffling money from one bit of an organisation to another.

And they also borrowed from central banks on a colossal scale. In the first half of 2010, domestic Portuguese banks' borrowings from central banks - largely what they borrow from the ECB and the Banco de Portugal - increased from €15.7bn to €39.7bn.

By the end of June, Portugal's domestic banks were financing a staggering 9.6% of their balance sheets by borrowing from the ECB and other central banks.

Now the Banco de Portugal says that these banks' dependence on central banks has fallen a bit since the end of June, but remains unsustainably large. It says: "the unsustainability of the permanent large scale use of Eurosystem financing will require a redefinition of Portuguese banks' financing strategy, particularly in a framework of persisting major restrictions on access to financing in the wholesale debt markets".

Or to put it another way, the ECB is signalling that it wants its money back. And the ECB has no option but to do so, because it is in the invidious position of having channelled eurozone taxpayers' money, via Portuguese banks, to the Portuguese government for the funding of a public-sector deficit - estimated by Barclays Capital at more than 7% of GDP this year - without ever having sought the permission of eurozone taxpayers.

The ECB simply cannot, over the long term, finance a structural hole in public sector finances. To do so would ultimately destroy its credibility and undermine the value of the euro.

Of course, the ECB can't have its money back tomorrow or even soon. Because if it asked for the cash, Portugal's banks would of course be bust - and so too would the Portuguese government, which has been kept afloat by loans from Portuguese banks.

But the ECB can insist that Portuguese banks must take steps to become viable organisations that can once more fund themselves from commercial sources.

Now here's the painful rub for the Portuguese government and people. The Portuguese central bank says "the furthering of a credible fiscal consolidation process is essential for facilitating the reopening of the international financial markets to Portuguese banks, thus allowing for a more gradual adjustment of the Portuguese economy".

Which means that the rehabilitation of Portugal's banks requires the Portuguese government to take credible steps to shrink its deficit, by raising taxes and cutting expenditure.

But in doing so, the Portuguese government would probably generate an increase in unemployment and a contraction in revenues for private sector businesses, in the short term at least. Which, the central bank says, means defaults on corporate and consumer credit loans - which are already running at a high rate - could rise further, generating increased losses for banks.

All that - along with the need for the banks to meet the new Basel lll capital thresholds - is why Portuguese banks have to raise billions of euros in additional capital, as a protection against those possible future losses.

Which implies that the Portuguese government and Portuguese banks will collectively have to raise a colossal amount of new money over the coming weeks and months.

Can they obtain those tens of billions of euros from commercial sources, in the way that Portugal's finance minister has been insisting is possible? Maybe.

That said, the disclosure by the Banco de Portugal that the Portuguese government has only kept its head above water by borrowing from the ECB via Portuguese banks rather suggests that - like Ireland - Portugal's financial rehabilitation will require a substantial package of loans from the EU and IMF.

What's a fair contribution from multinationals?

Robert Peston | 10:29 UK time, Tuesday, 30 November 2010


A recent McKinsey report From Austerity to Prosperity [3.19MB PDF] says this:

"Multinationals may only account for fewer than two percent of UK businesses, but they drive overall economic growth and innovation at scale, accounting for 80 percent of UK R&D, and growing productivity eight times faster than smaller firms. Government should work with leading multinationals to implement a ten year plan to make the UK the most attractive European location for multinationals, addressing skills, immigration, infrastructure and tax."

I suppose at this point I should point out the McKinsey and its partners have grown fairly prosperous working for multinationals. And some would say that a government ignores the wellbeing of smaller companies at great peril - and would point to how Germany, with its army of smaller manufacturing businesses, is powering out or recession. But the consultancy may have a point.

George Osborne

Certainly the Chancellor, George Osborne, seems to think so: he claimed yesterday that his planned reforms of corporate tax would "improve the attractiveness of the UK as a place for the private sector to locate and invest."

There are two elements to what Mr Osborne wishes to achieve, in tax changes that won't be legislated till 2012.

He wants multinationals located in the UK to feel more confident that the tax they pay here will be levied primarily on what they earn here, rather than on their overseas earnings. It was the concern that global earnings were subject to UK tax that, for example, persuaded the UK multinational WPP to relocate its domicile to Ireland.

Or to use the lingo, the chancellor has signalled a move to a more territorial basis for taxing multinationals profits.

He also wants those multinationals to conduct as much research and high-value production in the UK as possible, because of the putative benefits brought from the creation of high skilled and highly rewarded employment.

So Mr Osborne has said there'll be a new special low corporate tax rate levied on UK operations that exploit research carried out in the UK.

What is there to say about all of this?

First it is probably not quite the tax revolution claimed by Mr Osborne. The Treasury signalled this direction of travel before the election, when Labour was holding on to office by its fingertips.

Second, tax specialists complain that Mr Osborne is not being bold enough: they say, for example, that the so-called "patent box", the device for lowering the tax on profits earned from UK intellectual property, will benefit only a limited number of firms.

The patent box is likely to be a great boon to pharmaceutical companies, such as GlaxoSmithKline, which yesterday gushed on the importance of the research tax break, and confirmed it is investing up to £500m in expanding manufacturing capacity and in a new venture capital fund.

But Chris Sanger, head of tax policy at the accountants Ernst & Young, said:

"Despite pressure from UK businesses, the coalition has retained the policy of the previous government in relation to the development of a UK patent box. The reduced rate of tax will continue to apply only to patents, rather than a wider range of intellectual property such as royalties and brands...This will be a disappointment to multinationals outside of the pharmaceutical industry...Multinationals may be tempted to build new centres of development in other, more attractive countries".

Mr Osborne's corporate tax policy is however vulnerable to a more fundamental criticism, that it doesn't face up to the fiscal reality of a global economy dominated by multinationals, which is that trying to force them to pay tax in a particular country is like endeavouring to squeeze a giant blancmange into a small box: the more you try, the bigger the leaks.

That carries two conclusions. Either countries like the UK should go down the Irish route, of slashing the domestic rate of corporation tax and turning a Nelsonian eye to overseas earnings; or Mr Osborne should recognise (however painful that may be) that the days of national sovereignty when it comes to taxing multinationals are well and truly over, and there is nothing for it but to try to harmonise global corporate taxes.

The chancellor's ambition of "fairly" taxing multinationals' UK activities and profits, and imposing a controlled foreign companies charge on profits that in some sense have been "artificially" diverted abroad, is a worthy ambition, many would say. Whether it's remotely deliverable is altogether another thing.

Can the eurozone afford its banks?

Robert Peston | 10:29 UK time, Monday, 29 November 2010


Jim O'Neill, probably the most influential thinker at Goldman Sachs (as current head of its asset management division and erstwhile chief economist), has this morning written that "European Monetary Union (EMU) will probably survive, but it is likely to remain very messy".

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Which is hardly a ringing endorsement by the world's most powerful investment bank of the most ambitious economic and financial project in Europe of our age.

And, let us not forget, Goldman Sachs is not famous for issuing public statements that rile the world's most powerful governments - which tend to be its customers.

For O'Neill, the issue is about the governance of the eurozone, not about the magnitude of the debts of Europe's financially stretched economies. He points out that the sovereign indebtedness of Greece, Ireland and Portugal is huge relative to the size of their respective economies but almost de minimis in relation to the size of the eurozone as a whole.

Even Spanish debt represents "only" 5.3% of eurozone GDP, he points out.

So if Germany, France and the Netherlands were to properly underwrite the debt of their over-stretched neighbours, Europe would (in theory) have little more difficulty borrowing than the US - whose overall ratio of debt to GDP, at 80%, is more-or-less the same as the eurozone's would be, on a pro forma basis.

The verdict of the markets this morning, following last night's agreement on the structure of a bail-out for Ireland and on a new framework for eurozone financial rescues, is that Germany, France and the Netherlands are a long way from being prepared to properly guarantee the indebtedness of Greece, Ireland, Portugal, Spain and Italy.

The prices of Irish, Portguese, Spanish, Italian and Greek government bonds have hardly moved this morning. The implied interest rate that they would have to pay to borrow for 10 years remains way above normal levels, and a mile above what Germany pays: it's 9.12% for Ireland, just under 7% for Portugal, 5.2% for Spain, 4.45% for Italy, and 11.9% for Greece.

What investors have registered is that, far from saying they'll honour the debts of the so-called peripheral countries, Germany, France and the Netherlands last night sent out an unambiguous message that they want the risks of lending to weaker countries to be born in part by the lenders.

European finance ministers announced new arrangements for rescuing eurozone members to replace the €440bn European Financial Stability Facility from 2013. And these would include the insertion of "collective action clauses" into bonds issued by eurozone countries from June 2013 onwards.

These collective action clauses would make it easier for debtors to force losses on creditors - by, for example, lengthening the term of the debt, altering the interest rate or writing off some of what is owed - so long as a "super-majority" of debtors agreed.

European finance ministers have in effect announced that the risks of lending to financially stretched eurozone countries would increase in two and a half year's time - which is no time at all for many investors.

In practice this means that the eurozone has set itself a deadline of two and a half years to persuade investors that its finances are in order. If it fails to do so, a whole host of weaker eurozone states could find they are confronted with punitive borrowing terms or even a strike by lenders.

If this isn't causing a degree of anxiety for the governments of Portugal, Spain and Italy, then it probably should be. Because, according to figures from Bloomberg and Moodys, they collectively have to refinance more than €165bn of existing debts in 2013 - which takes no account of what they'll need to borrow to finance whatever gap there is between their spending and tax revenues in that year.

What also needs to be pointed out is that O'Neill's relatively sanguine analysis of the challenge for the eurozone takes no account of the financing needs of the eurozone's banks - which can be seen as contingent liability of the public sector.

In the case of Ireland, the banks are now a real liability of the state - and the better news for the Irish government this morning is that the share prices of Bank of Ireland and Allied Irish Bank have risen, following the provision of €35bn for recapitalising Ireland's financial system.

That said, Allied Irish is on its way to being more-or-less fully nationalised, and Bank of Ireland will struggle to avoid becoming majority owned by the state.

What some investors will find disturbing however is that this public-sector rescue of Ireland's banks is predicated on the idea that the banks' creditors will be reassured by a lifting in their capital resources from 8% of assets to 12%.

The fact is that a 12% "core tier 1 capital" ratio - while it may be a multiple of the protection that was in place for banks three years ago - will be seen as still too low by some investors and many international regulators.

Given the size and importance of Bank of Ireland and Allied Irish in relation to the Irish economy, a much higher capital ratio - or greater protection against future losses - could be seen as appropriate (as I pointed out in an earlier post).

Here is what may spook investors in eurozone banks in general - that the IMF and EU may have shied away from putting pressure on Ireland to increase the capital resources of its banks further for fear that to do so would shine a light on what may be seen as a relative shortage of capital in the eurozone's banks in general.

For Europe's very biggest banks, the ratio of their assets to their equity capital is 50% greater than for the UK's banks and 100% in excess of the so-called leverage ratio of big US banks, according to Bank of England calculations. Or to put it another way, Europe's giant banks appear to be taking far bigger financial risks than US and UK banks in relation to the reserves they retain as protection against potential losses.

So here's the big question. O'Neill may well be right that a reformed, integrated eurozone could cope with the aggregated sovereign debts of its members. But it is altogether another question whether even Germany could afford to underwrite the liabilities of the eurozone's monster banks, if creditors started to seriously question whether those banks have sufficient capital.

What the UK is contributing to Ireland

Robert Peston | 19:21 UK time, Sunday, 28 November 2010


The UK will provide a direct loan to Ireland of £3.2bn (€3.84bn).

The interest rate is expected to be around 6%, although the Treasury is not confirming the precise terms.

Denmark and Sweden are together lending around £1bn to Ireland, so the UK's contribution is the biggest direct loan to Ireland.

On top of that, the EU's two multi-lateral funds will contribute €40bn of rescue finance to Ireland.

The Chancellor George Osborne believes he has wrung an important concession from other EU countries in return for providing this loan to Ireland: he has secured an agreement, I am told, that the UK will not be part of the new rescue fund for eurozone countries to be launched in 2013.

That will replace the existing rescue mechanism, in which the UK has a participation (the UK has a share in the €60bn European Financial Stability Mechanism, but is not part of a €440bn European Financial Stability Fund).

Mr Osborne hopes the eurosceptics in his own party will be reassured that Britain won't participate in eurozone bailouts after 2013.

I have also learned that the European Union is charging much more for its €45bn of bilateral and multilateral loans to Ireland than the IMF is charging for the €22.5bn it will be lending.

The interest rate being charged by the EU will be around 6%, whereas the IMF will charge just over 3% for the first three years and 4% for the subsequent three years.

The relatively high rate of interest being charged by the EU is bound to stoke up controversy in Ireland.

In addition, Ireland will be contributing €17.5bn of the total €85bn rescue package from its own resources: €5bn will come from the government's own cash holdings and €12.5bn from its sovereign wealth fund, the National Pension Reserve Fund.

The average maturity of all the €85bn of rescue loans will be seven years.

Brian Cowen, the Irish prime minister, disclosed that interest payments on all Ireland's sovereign debt - including the rescue funds - will be equivalent to a full 20% of Irish tax revenues by 2014.

He also confirmed that there would be no haircuts or write-offs for providers of senior debt to Ireland's weakened banks - though he said that the balance sheets of these banks would be radically shrunk.

Update 21:00: Of the €35bn earmarked for the strengthening of Ireland's banks, €10bn will be invested immdediately as fresh capital and €25bn will be held back as a contingency fund.

The capital is required because Ireland's banks have been set a new 12% target for the ratio of their "core tier 1" capital to assets.

According to the Irish regulator, the Irish central bank, that means Allied Irish will have to raise an additional €5.3bn of capital and Bank of Ireland will have to raise a further €2.2bn.

The consequence will be that AIB will be more-or-less 100% owned by the state.

As for Bank of Ireland, it is likely to have a stab at seeing if commercial investors will provide the €2.2bn needed. But the chances are it'll have to obtain the funds from the EU/IMF rescue pot, which means it will be well on its way to being fully nationalised.

Or to put it another way, Ireland will not have any kind of private-sector financial system for many years to come - which reflects the appalling risks these banks took.

The banks are also being cut down to size, by hiving off their more poisonous loans and forcing them to sell "non-core" assets.

In order to facilitate the sale of these assets, their value may be guaranteed by the state.

Update 21:10: The total British contribution to the rescue of Ireland can be seen as €7.8bn (£6.6bn) - consisting of a direct loan of €3.8bn, plus exposure equivalent to 4.5% of the IMF's €22.5bn loan (or €1bn) and 13.5% exposure to the European Financial Stability Mechanism's €22.5bn contribution (€3bn).

Interestingly the €3.8bn direct loan is greater than the UK's contribution would be if we were part of the European Financial Stability Facility, the bailout fund which is exclusively financed by eurozone members - which is contributing €17.5bn to the bailout of Ireland.

Or to put it another way, the UK is doing more than the basic minimum to help Ireland out of its predicament.

Germany wants punitive interest rate for Ireland

Robert Peston | 16:51 UK time, Sunday, 28 November 2010


European finance ministers are struggling to reach agreement on the interest rate to be paid by Ireland for the €85bn of rescue finance it is set to receive from the EU and IMF - although they appear to have reached a settled position there should not be losses imposed on providers of senior debt to Irish banks.

As I understand it, the German finance minister, Wolfgang Schauble, is arguing that Ireland should pay a higher interest rate of around 7%. His demand is thought to reflect the chronic unpopularity in Germany of the country's participation in bailouts of financially weaker EU states, such as Greece and Ireland.

So the German government feels that any rescue loans should not look like cheap money, but should be charged at an interest rate that contains an element of punishment for the reckless borrowing spree of Ireland's banks, which took the Irish economy to the brink of bankruptcy.

Ireland would plainly want to pay less. And it is thought that the UK is supporting the Irish position, for fear of the damaging consequences for financial stability if the Irish state were burdened with an unaffordable rate of interest.

Although initially Ireland believed it would pay 5%, a compromise of around 6% may eventually be agreed.

A source close to the talks in Brussels told me that the finance ministers' meeting is still at least a couple of hours from finishing - and the wrangling could go on for longer.

"This issue of the interest rate is not proving easy to settle," he said. "There is still a faint chance we won't reach agreement tonight".

As and when the finance ministers reach agreement on the rescue package - which is expected to be worth €85bn in total, of which €50bn would be earmarked for funding Ireland's deficit and €35bn for shoring up its weakened banks - the deal will still not be done. It would still have to be approved by the board of the International Monetary Fund, which could take several days.

Also it will take some days to distribute the €35bn portion between Ireland's needy banks, led by Anglo Irish, Allied Irish and Bank of Ireland.

Owners of billions of euros of bonds issued by these banks that is classified as senior debt will be deeply relieved that "haircuts" - or reductions in what they're owed - will not be imposed on them.

As I understand it, the EU largest economies are deeply worried that forcing losses on these bondholders could shake confidence in many other European banks.

However holders of subordinated debt will be forced to endure formal writedowns of the billions of euros owed to them.

Update 17:45: Rescue deal agreed. Taoiseach to announce details at 18:30. I will file again later.

What losses for lenders to Irish banks?

Robert Peston | 13:33 UK time, Friday, 26 November 2010


There is, as I've written here many times, a powerful moral case for imposing some of the costs of rescuing Ireland on those banks and financial institutions which fuelled Irish banks' reckless lending binge by lending to them (see my post from September).

But there are also powerful practical arguments why to do so might turn a calamity into financial disaster, for Ireland and for the eurozone.

Bank of Ireland exit sign


So, against that background, I am gripped by an article in today's Irish Times which says that the team from the IMF, ECB and EU, that is negotiating the detail of Ireland's 85bn euro rescue package, wants to impose write-downs on providers of both subordinated and senior debt to Irish banks.

Now depending on what this entails, it is explosive stuff.

Least controversial - and, according to my sources, a done deal - is that providers of so-called subordinated debt to Allied Irish Banks will be asked to write off a significant proportion of what they're owed. With most of that debt trading at close to 30 cents in the euro, it's clear that investors in these loans are braced for hideous losses.

There's almost as bleak a prospect for holders of Bank of Ireland's subordinated bonds, which are trading at between 40 cents and 50 cents in the euro.

So there will inevitably be a few billion euros of losses for one group of Irish banks' creditors.

But the picture for so-called senior lenders is altogether less clear, according to officials to whom I've spoken this morning.

There are two categories of senior debt: there are loans guaranteed by the Irish state, and there are loans that aren't guaranteed.

Now if providers of guaranteed loans to banks were asked to write down the value of what they're owed, that would be exactly the same thing as asking lenders to the Irish government to write down their loans: it would be a haircut on sovereign debt.

Which would, at a stroke, completely alter the perception of the value not only of Ireland's sovereign debt, but also that of all the eurozone's other financially stretched economies, from Greece, to Portugal, to Spain and so on.

Or to put it another way, it could significantly escalate the eurozone's financial crisis and would run counter to everything that European governments have so far said they're trying to achieve.

So the Irish government remains hopeful - if a bit less confident than it was - that the EU/IMF team will not demand that providers of guaranteed bank debt should incur losses.

What about the senior debt that hasn't been guaranteed by the Irish state? Well the arguments against demanding that providers of those loans agree to reduce what they're owed are partly that there are substantial legal hurdles and also that there could be serious contagion to the valuation of senior loans to other eurozone banks - which could seriously damage important banks in other countries.

But, I have to say, no one in a position to know has yet told me that the IMF/EU team won't try to impose some kind of burden sharing on providers of unguaranteed senior bank debt. Which means that there'll be an anxious 48 hours or so for holders of this debt, since we should know the essence of the bank rescue proposals for Ireland on Sunday.

All that said, even if formal write-downs aren't imposed on holders of different categories of bank and sovereign debt, it's as well to remember that the verdict of the market is that almost every category of loan to Ireland is worth less than face value - with discounts varying from 80% to 10%, depending on security and guarantees.

What does that mean in terms of potential shock to the global economic system?

Well total claims on Ireland by banks - that's the aggregate of their loans to Irish banks, companies, households and state - are just over £460bn.

Market prices for debt imply that no more than two-thirds and perhaps as little as half of that £460bn can be repaid over the longer term: with investors currently putting a price of 73 cents in the euro on 10 year loans to the Irish state, and 30 cents in the euro for subordinated loans to AIB, it's probably reasonable to assume that direct loans to Irish households (for example) are fundamentally worth somewhere between those two numbers.

This implies that global banks will have to swallow losses of between £150bn and £230bn on the credit they've provided to Ireland, either in formal write-downs over the coming days or through a pernicious process of bankruptcies and rescheduling over the coming months and years. And, by the way, those would only be the losses for banks: there would be additional pain for other financial institutions - money market funds, hedge funds, pension funds, insurers and so on - which have also lent to Ireland.

The market's valuation of Ireland's debts may be wrong of course. But it should be clear why a financial earthquake in an economy a tenth of the size of the UK's is reverberating from Asia to North America.

Why the Treasury won't illuminate 2010 bank pay

Robert Peston | 08:59 UK time, Thursday, 25 November 2010


Over a 10-year period, the share price performance of Britain's banks has been appalling (in the case of Royal Bank of Scotland and Lloyds/HBOS) or lousy (Barclays and HSBC).

Over the same period (you probably won't need reminding) the remuneration of top bankers has soared, both for those who run the banks and for their star traders and advisers; the early part of this millennium was the period when the multi-million pound bonus package proliferated and became entrenched into the system.

As for dividends, after the crash of 2008 banks either eliminated them (RBS, Lloyds, Barclays) or slashed them (HSBC).

So it's been a great time to work for a bank, and simply the worst time to own shares in a bank. Which would look like prima facie evidence that the balance between rewards for bank employees and rewards for the owners have been skewed too far in favour of the employees.

That is bad news for those of us still brave enough to save for a pension, since there'll be a slug of bank shares in our portfolios (whether we asked for them or not).

So why on earth haven't the owners or those who manage big pension and insurance funds on behalf of the ultimate owners (that's us by the way) demanded more for themselves and insisted on less for those who destroyed the value of their (our) banks?

There is another facet to this puzzle. Research by the Bank of England shows that if banks reduced the proportion of their revenues that they pay out in pay and bonuses back to what it was in 2005 (which was a pretty good year for the banks), they would free up £10bn - which could be used to strengthen themselves by retaining it as capital (which is what the Bank of England and FSA would prefer) or to pay higher dividends.

To put it another way, the failure of the owners to insist that this £10bn be deployed to reinforce the foundations of their banks or provide an income to them is one of the great mysteries of our time.

The previous government spotted that when it came to setting pay, shareholders appeared to have abdicated all responsibility. So it took advice from a senior banker and former regulator, Sir David Walker, and decided to help the owners put pressure on banks that were paying too much, by forcing the banks to disclose much more detail about what they pay.

It prepared draft legislation that would have forced bankers to disclose every year how many of their people earned more than £500,000 but less than £1m, how many earned more than £1m but less than £1.5m, and so on, in bands of £500,000, until the threshold of £6m was breached, at which point the disclosure bands would have widened to £1m.

The legislation never made it on to the statute book, because the general election intervened. But both George Osborne, the Chancellor, and Vince Cable, the Business Secretary, always said they were in favour of improved disclosure of bankers' pay, so the widespread assumption was that the statutory instrument would become law in time for the pay information to be included in the banks' next annual reports.

That's not going to happen: the new law on executive remuneration in financial services has been shelved, as the prime minister confirmed during Prime Minister's Questions yesterday.

Why? Well, you probably won't need telling that those who run British banks have for some time been telling me how much they dreaded having to reveal how many of their people earn seven figures and above.

However, in defending the status quo, David Cameron pointed to a public change of heart by Sir David Walker, who earlier this week wrote in the Financial Times [registration required] that he didn't think it was appropriate for UK banks to be forced to disclose more information on what they pay than US banks, or French banks, and so on.

This is what Sir David said:

"[A]ny attempt to require banded disclosure for UK banks in isolation would be commercially sensitive vis à vis their non-disclosing competitors elsewhere. It could also stimulate higher executive turnover, and (as a perverse unintended consequence) lead to higher remuneration as a defensive retention measure."

You'll have to judge whether you think the potential competitive cost to British banks outweighs the potential benefits for the owners of banks in having the information that would enable them to engage in an informed dialogue with bank bosses on an aspect of management with profound consequences for the strength and sustainability of banks.

The Treasury says that Mr Osborne will write to European Union finance ministers, to press for a Europe-wide bank pay disclosure regime. It insists that a light may yet be shined on what bankers are paid.

We'll see. What however is as dead as any dead thing is the notion that British banks could be forced to lead global moves towards greater illumination of bankers' pay.

How much capital do Ireland's banks really need?

Robert Peston | 09:23 UK time, Wednesday, 24 November 2010


There's a funding crisis in the eurozone, inflation in China and anaemic growth in the US.

That's a pretty lethal combination when it comes to investors' appetite for risk.

Or to put it another way, there are reasons to believe that a global recovery in the price of shares and riskier assets may have come to an end - and it is far from easy to predict when it will resume.

As for the minuscule but potent nexus of this turmoil, the Irish financial crisis, the news overnight isn't good.

The ratings agency S&P has downgraded Irish sovereign debt by a couple of notches - which is yet another blow to the price of Irish government debt and the ability of the state to fund itself.

There will be many who will bemoan the continued influence of ratings agencies such as S&P, the fact that their ratings are "hard-wired" into the system that determines whether governments and vital institutions can raise money: the G20 leaders have pledged to reduce the power of the agencies, but have so far actually done precisely zip (a big hello to that galloping horse and the wide open barn door).

Entrance of the Bank of Ireland's head office


Against this background of risk aversion and the painful trial that lies ahead for the Irish state in trying to regain credit-worthiness, what kind of ratio of capital to assets would actually persuade commercial banks and investors to lend to Irish banks - and would stand a chance of breaking the vicious connection between the funding crisis of the banks and the funding crisis of Irish government?

The IMF, European Central Bank and European Commission - who are in Dublin divvying up €35bn of rescue funds for Ireland's banks and €50bn to fill the state's direct funding gap - are signalling that a ratio of 12% might do it:so that would require Ireland's big banks to hold equity capital equivalent to 12% of their loans and investments, as protection against future losses.

The current capital ratios of Bank of Ireland and Allied Irish Banks are a good deal less than 12%, so they would need to raise billions of euros of additional capital. AIB could only get this from the IMF/EU rescue fund, so it would become - at best - a whisker away from 100% nationalised.

As for Bank of Ireland, it would be largely nationalised, unless it can somehow persuade its long suffering investors to stump up a colossal amount of risk capital (which is even less likely than my team, Arsenal, breaking its long run of trophy-less seasons - yes, I'm in pain).

Even so, it's not obvious that a 12% ratio of capital to assets will reassure lenders enough such that there's any chance that they'll start lending to Irish banks again, or stop withdrawing their credit, on any useful timetable.

And the reason is Swiss. What I mean by that is that the Swiss authorities have recently ruled that the two biggest banks in Switzerland must hold equity plus bonds that automatically convert into loss-absorbing equity when needed that would be equivalent to 19% of assets.

Now there are similarities and differences between the Swiss banks and the Irish banks. The important similarity is that the domestic market shares of UBS and Credit Suisse, on the one hand, and Bank of Ireland and AIB, on the other, are pretty similar. Or to put it another way, UBS and Credit Suisse are huge in Switzerland, whereas Bank of Ireland and AIB are similarly vital to the functioning of the Irish economy: the argument of the Swiss, which many would find compelling, is that banks deemed more important to the functioning of an economy should be forced to hold relatively more capital than less important banks, because those systemically vital banks can't be allowed to fail.

Then there are important differences: Bank of Ireland and AIB have concentrations of risk, in the fragile property and housing markets, well in excess of UBS and Credit Suisse; Switzerland has one of the strongest economies in the world, and Ireland (ahem) doesn't; the credit of the Swiss government isn't in doubt (and you know what investors currently think about the Irish government's ability to repay all its debts).

So if 19% is the right ratio of capital to assets for UBS and Credit Suisse, it is possible to argue that 25% or more would be appropriate for Bank of Ireland and AIB.

Is that in fact where the IMF, ECB and European Commission will end up, when they finish their review of Ireland's financial requirements?

Well, it's not impossible. There are those at the IMF and ECB who will see the logic. But it would be very tricky for European governments to see Ireland's banks capitalised to that extent - because it would serve to highlight the number of other banks in vulnerable eurozone economies that have relatively little capital.

In other words, putting the ideal amount of capital into Ireland's big banks would raise the potential costs of any future rescues of eurozone economies and banking systems that may be needed.

On the other hand, some would argue, if the Irish economy and its banks are going to be rescued, better to do it properly, in a completely watertight way, rather then leave nagging doubts that the repair is a bit of a botch.

Update, 15:30: At the press conference announcing Ireland's National Recovery Plan, the finance minister Brian Lenihan gave a little bit of extra detail on how 35bn euros of IMF and EU money will be deployed to help Ireland's banks.

As we know, a chunk of this will be invested in Ireland's banks, to augment their capital resources, their shock absorbers against losses.

But Mr Lenihan said there would be two other dimensions to the rescue.

Ireland's toxic bin for the banks' lossmaking loans, the National Asset Management Agency, will be expanded, so that the balance sheets of Allied Irish Bank and Bank of Ireland can be shrunk and sanitized.

Also, Mr Lenihan acknowledged that Ireland's scheme for guaranteeing the borrowings of the banks, the Eligible Liabilities Guarantee Scheme, isn't providing the reassurance to lenders that it might, so it will have to be strengthened - presumably by putting the resources of the IMF and the EU behind the scheme.

PS As if the Irish haven't sacrificed enough, the Irish government has announced that it will create a new four-year "Solidarity Bond" so that the Irish people can lend to their government, to help fill that yawning gap between public spending and dwindling tax revenues.

What the government doesn't say is whether the terms and interest rate on this bond will be better or worse than the terms that'll be demanded by the IMF and EU on the credit they're providing.

Also there will be legislation to allow Ireland's sovereign wealth fund, the National Pensions Reserve Fund, which has just under 25bn euros of resources - a tidy sum - to "support the Exchequer's funding programme to the extent required".

Or to put it another way, if Ireland can't borrow from commercial investors, it will be able to borrow from the state's captive investment fund, so that Ireland's pensioners of tomorrow can bail out the public-sector employees of today.

Update 1705: Bond markets have given a massive thumbs down to the Irish National Recovery Plan, which rather implies that investors don’t think it’s deliverable in Ireland’s traumatic political climate.

The yield on the Irish 10-year bond has risen to 8.89% – yikes, back to record levels.

As for strike-riven Portugal, whose banks (like Ireland’s) are excessively dependent on central bank support (to the tune of more than 8% of their liabilities, on my estimates), its 10-year government bonds are yielding 7%.

Meanwhile the yield on the Spanish 10-year has crept over 5%, for the first time since 2002.

When benchmark bond yields rise in this way, there’s a knock-on to the funding costs of banks: it becomes more expensive for banks to borrow.

So to return to my boring refrain of late, this little local Irish difficulty still has the potential to wreak havoc across the eurozone and beyond.

Now normally in circumstances like these, when investors become anxious about risks, there’s a flight into supposedly uber-safe German bonds. That hasn’t happened today: the yield on the “bund” (traders’ vernacular for the German’s 10-year) has risen a bit, from 2.55% to 2.71%.

What should therefore perhaps worry the German government is that anxiety about the finances of Ireland and Portugal is infecting even the perceived credit worthiness of Germany (well, on the margin anyway).

The financial truth hurts Ireland

Robert Peston | 19:08 UK time, Tuesday, 23 November 2010


European governments hoped that their unambiguous signal on Sunday night of their intention to provide around £75bn of rescue loans to Ireland would calm investors - and stop the fall in the price of debt of the more financially challenged eurozone states.

It hasn't happened.

Irish government bond prices fell sharply today, to levels almost as low as at the height of the recent crisis - which would mean that the Irish government would have to pay a prohibitive 8.4 per cent rate on a ten-year loan, if investors were prepared to lend to it, which they're probably not.

And there was contagion to the debt of a much bigger economy, Spain, whose bonds also dropped - such that the gap between what the Spanish government would have to pay in interest and what the German government pays widened to a record.

That means investors are more worried than they've ever been about the ability of Spain to honour its debts.

As for Ireland's fragile banks, their share prices fell - and there was contagion to the prices of overseas banks, including the UK's.

What caused the global tremours, which also saw stock markets fall?

Well it was largely the fear that Ireland's political instability would de-rail the international rescue - which may seem extraordinary, in that Ireland's economy is tiny.

But it only goes to show, again, how dangerously and intricately intertwined are global banks and national economies.

By the way, I don't know whether it adds to or detracts from financial stability that Ireland's central bank governor, Patrick Honohan, has again been refreshingly frank today, in an address to the Chartered Accountants Ireland Financial Services Seminar (yes, I know it's not fair that we weren't all able to get tickets).

Mr Honohan admits that Ireland's banks have been hopeless at making adeqate provisions for expected losses on their poor loans or in keeping investors abreast of the risks they take.

Little wonder then that the Irish banks' creditors trust them so little, and have been pulling out their money by the tens of billions of euros, till the banks - and the Irish state that stands behind them - have been taken to the brink of collapse.

Mr Honohan also points out that Ireland's official GDP and unit labour cost statistics have consisently overstated the size of the Irish economy and its productivity respectively - largely because that economy is so dependent on multinationals with headquarters in the Republic, whose high profits acrrue to the overseas owners of those multinationals rather than to Irish residents.

That overstatement of the magnitude of the output of Irish residents, which in some real sense is attributable to those residents, could be as much as quarter, he says.

Which implies of course that the ability of Ireland to repay its enormous bank and state debts is even worse than the eye-poppingly high ratios of borrowing to GDP would imply.

Ireland: An extreme version of the British disease

Robert Peston | 08:22 UK time, Monday, 22 November 2010


Any Briton tempted to gloat over the woes of Ireland should probably think again, in that Ireland's financial crisis could easily have been the UK's.

The point is that Ireland's flaws are an extreme version of what happened here:

Grafton Street

Grafton Street, Dublin

1) Banks that became too big and too dependent on overseas borrowing relative to the size of their respective economies;

2) Banks that lent far too much to commercial and residential property, fuelling an unsustainable boom that has gone pop;

3) Governments that became too dependent on property taxes which collapsed when recession set in - contributing to the emergence of a black hole in the public finances;

4) An overall burden of debt, aggregating household, banking, commercial and state borrowing, that was a humungous 700% of GDP in Ireland and an eye-popping 400% of GDP in the UK (more than for any other big rich economy apart from Japan).

Why has Ireland had the humiliation of being forced to admit that it is unable to pay its way in the world whereas the UK government is still able to borrow vast sums at record low interest from commercial lenders and can swank that it has the means to be a generous rescuer of Ireland?

There are a number of reasons, which probably include how the UK has tackled its own recent financial crises and that the UK has an independent currency and central bank. Even so, Ireland's dismal fate could easily have been the UK's - and, if global financial storms were to rage again, could yet be.

Obviously the important question now is whether the European Union's rescue of Ireland has sealed in the infection, allowing the rest of the eurozone economy to recover, or whether it simply provides temporary respite. To put it more bluntly, will Portugal be next?

Portugal insists it can muddle through. But that is not being taken for granted by the European politicians and officials to whom I've spoken in the past 24 hours, because although Portugal's banks are not as bloated or as weak as Ireland's, its private-sector economy is arguably less robust.

For what it's worth, if Portugal were to go cap-in-hand for loans to the European Union and International Monetary Fund (IMF), the UK would be less prominent in the rescue, officials tell me - for the self-interested reasons that Portugal is rather less intertwined into the British body politic/economic than Ireland.

PS: The shape of the Irish rescue is being slightly clearer.

The total size of the bail-out package is expected to be between 80bn and 90bn euros. Of this, something over 30bn euros is expected to be earmarked for injecting additional capital into the banks, to strengthen them against future losses.

The bank most conspicuously in need of additional financial support is Allied Irish Banks. Of course, Anglo Irish Banks is weaker, but the government already put it on a path to being wound up. What's less clear is whether Bank of Ireland will become largely nationalised in this new round of reinforcing the Irish financial sector.

The UK's share of the Irish package of succour, including indirect loans and a possible direct bilateral loan, might well be 9bn euros.

Update 1057: Over the past 24 hours, I have been asked countless times how the UK government can afford to provide around £7bn of support for Ireland - through indirect and possible direct loans - at a time when it is struggling to reduce its own deficit.

Well the answer, as many of you will know, is that unlike Ireland, the UK is currently having little difficulty borrowing record amounts at comparatively miniscule rates of interest.

If the UK were to lend to Ireland for three years at an interest rate of 5% or more, which seems likely, that - in theory - would yield a profitable turn for the UK exchequer of perhaps 3 percentage points (or 300 basis points, in the jargon).

It would be good business, on the reasonable assumption that Ireland repays the UK.

Also, for those who say the £7bn could be better deployed funding schools or hospitals, or paying to keep civil servants in work, it's important to remember that - over the long term - the road to ruin is the fork in the road where public spending is permanently financed through borrowing rather than taxation.

That said, borrowing to invest - to build schools, hospitals, railway lines or low-carbon power plants - can be seen as sensible.

In fact, there are some who argue that the UK should take advantage of low interest rates to increase infrastructure investment, with the aim of improving the productivity of the economy (a fascinating new report by McKinsey argues that one of the great priorities for the UK should be to invest around £520bn in infrastructure over the next two decades).

Update 1300: For the avoidance of doubt, the British contribution to the Irish rescue will be less than 10bn euros  (£8.5bn) in total, sources tell me.

That would be the total, including a bilateral loan of indeterminate size and the UK's indirect contribution via the IMF and the European Financial Stability Mechanism.

The balance between direct and indirect loans is yet to be agreed.

Ireland: The rescue is official

Robert Peston | 15:03 UK time, Sunday, 21 November 2010


There will be formal confirmation this evening from the Irish government that it is applying for rescue loans from the European Union and the International Monetary Fund (IMF).

Since the request won't be refused, this can be seen as a "high-level" announcement that the rescue is happening, according to officials.

There is expected to be a statement from the finance ministers of the EU's member states welcoming Ireland's application for financial support.

The total value of these loans - or more properly of these lending facilities - is expected to be less than 100bn euros (£85bn), although the definitive amount won't be fixed for a few days, until a team of experts from the IMF, European Commission and European Central Bank has finished their evaluation of the "hole" in the finances of Ireland's big banks.

The lending facility for Ireland is expected to have a life of three or four years, long enough (in theory) for Ireland to restore the health of its banks and to reduce the deficit in its public finances from 12% of GDP (excluding taxpayers' financial support for banks) to a target of 3%.

It is hoped that would be long enough for Ireland to restore its reputation as a credit-worthy nation among commercial lenders and investors.

The UK will contribute to the rescue package, even though - unlike Ireland - it is not a member of the eurozone. What is less clear is whether the UK will make a direct, bilateral loan to Ireland, or whether the UK's help will be via its position as a shareholder in the IMF and as a participant in the 60bn-euro (£51bn) European Stability Mechanism.

The Chancellor, George Osborne, is considering the provision of a direct loan to Ireland, because the UK is not a member of the 440bn-euro (£376bn) European Financial Stability Fund, which will make the biggest contribution to the rescue package, and because the UK and Irish economies are closely intertwined, both in terms of trade and in the role played by Irish banks in Northern Ireland.

The way was cleared for Ireland to make an application for help from the EU and IMF by a statement made by President Sarkozy of France that EU member states would not insist that the Irish government abandon its cherished low rate of corporate tax.

On Tuesday, the Irish government is expected to set out its updated deficit reduction plans.

However there is unlikely to be agreement for several more days on how the emergency loan of up to 100bn euros from the EU and IMF splits between financial support for Irish banks and a more general lending facility for the Irish government.

Even so, investors and banks are expected to be reassured by tonight's formal statements from the Irish government and the EU that rescue loans have been requested and are expected to be provided.

Update 1652: Although it has been inevitable for several days - and on its way for months - Ireland's decision to request financial help from the European Union and International Monetary Fund is momentous.

And the reason is that until two years ago, Ireland looked like Europe's greatest economic success story.

Over 20 years, it grew at rapid rates that are more typical of Asia's fast-growing economies - until its GDP per head overtook that of the UK.

But much of the growth during the current millennium came from massive unsustainable borrowing on international markets by Ireland's banks. Those banks in turn pumped up a dangerous property bubble - which has now exploded - by lending far too much to developers and home-owners.

It will be some days before we know precisely how much of the rescue loan goes towards mending Ireland's fragile banks and how much is lent to the government - so that the government (whose grip on power is shaky) can be sure of filling the excessive gap between what it spends and dwindling tax revenues (until that gap is closed by massive spending cuts and tax rises over the next four years).

But, in the meantime, Ireland's admission that for now it cannot pay its way in the world proves - some would say beyond any reasonable doubt - that the Irish model of economic success is seriously flawed.

Update 2140: The British contribution to the Irish bailout could be fairly substantial. As well as contributing indirectly through the 60bn-euro European Stability Mechanism and the IMF, the UK Treasury has tonight officially confirmed for the first time that it may provide a direct bilateral loan.

Sweden, like the UK, may also provide a bilateral loan.

The rationale for a direct British contribution to Ireland's rescue package is that the UK is a substantial purchaser of British exports and Irish banks play an important role in Northern Ireland.

Also, Royal Bank of Scotland has £53bn of "credit exposure" to Irish borrowers. So the bigger the crisis in Ireland, the worse the losses on these loans - which would hurt British taxpayers both as owners of more than 80% of RBS and as insurers of many of these loans through the Treasury's asset-protection scheme.

In that sense, there is financial logic for the British government to participate in rescuing the Irish economy, to limit losses for British taxpayers.

Ireland: The big uncertainties

Robert Peston | 15:38 UK time, Thursday, 18 November 2010


This morning's interview with the Governor of the Central Bank of Ireland, Patrick Honohan, is a gem and Mr Honohan has instantly become a hero of mine.

Patrick Honohan


The reason is that Mr Honohan is refreshingly frank. He is the antithesis of the buttoned up, central bankers that are typical of his secretive and rarefied trade.

My favourite moment was when he was asked whether the Irish central bank has given super-special emergency loans to Irish banks that have been unable to obtain funding from the markets and from the European Central Bank's emergency liquidity facility.

This is what he said:

"All I'll say is there has been such a need, but I don't really want you to press me on that, because I'm not allowed to talk about these things on a current basis. Of course I'd have to make sure...just in case it would sound as if I'm exceeding my powers, I would have to make sure that the other members of the ECB, the governing council, don't object to making these loans".

So that would be a yes then. Which means that however much it has been obvious that Irish banks are finding it almost impossible to raise finance from commercial sources, the reality is probably worse

But I suppose what is more striking is that with all Mr Honohan's openness, there remain big uncertainties about the nature of the financial rescue being put together.

This is what we know.

What's being discussed with the European Union and the International Monetary Fund are loans and facilities with an aggregate value of tens of billions of euros, probably around 80bn euros or so, according to an official source.

The interest rate on that would be around 5%, according to Mr Honohan.

Which for Ireland is cheap money, since the government's 10 years bonds are currently trading on a yield of well over 8% - so if the Irish government were to borrow in the market (which it neither wants or needs to do till well into next year) it would have to pay interest greater than 8%.

But what we don't know is whether the bulk of that 80bn euros odd will be an actual loan or a promise of a loan, a borrowing facility.

It would be far cheaper for the Irish government if markets were to be reassured by the existence of a substantial borrowing facility - because Ireland would only pay the full 5% interest rate on drawn down loans.

However, the biggest uncertainties of all are even more basic. First, what is the fundamental problem that needs to be fixed? And second, how can that problem be fixed?

To state the obvious, and as I've been banging on about for days, it is the perceived weakness of Ireland's bloated, lossmaking banks that is the fundamental problem.

That said, is it the case that these hobbled banks would be able to borrow from commercial lenders again, and would become less dependent on the European Central Bank for funds, if all that happened was that a few more tens of billions of euros was injected into them as new capital, as additional protection against losses?

Or would investors and banks still be wary of lending to these banks, if they felt that the entity standing behind the banks - the Irish state - remained a credit of dubious worth?

If that were the case, the European Union and IMF would also have to make substantial funds available for use by the Irish government in funding its own direct deficit.

Finally, the other huge unknown is over the other strings and conditions that would be attached to the loans or borrowing facilities.

In particular, will Germany get its way and force the Irish government to raise its 12.5% corporate tax rate, which the German government has long seen as unfair tax competition, as a de facto bribe to big international companies to settle in Dublin?

Irish sources tell me they are confident they will not have to surrender this central plank of their industrial policy. Their main argument is that if they were to raise the rate, they could actually end up with less tax revenue, because a load of mobile multinationals - such as Google or WPP - would relocate elsewhere, perhaps Switzerland.

Curiously the Irish government's preferred tax-raising measure, I am told by officials, is to increase the number of citizens paying income tax, by lowering the income threshold at which income tax is payable.

I'm not sure whether the economics of keeping corporation tax low while raising more from low-income families quite works. But the politics is certainly very intriguing.

PS A further uncertainty is whether the banks need an injection of plain vanilla capital, or access to what Ireland's finance minister, Brian Lenihan, today called "a contingency capital fund that can stand behind the banks". Again this is a distinction between cash for the ailing banks now and the promise that cash will be delivered in certain (bad) circumstances.

Update, 17:11: If the problem to be solved is that Ireland's banks have borrowed too much from the European Central Bank, some £110bn, what possible benefit would there be of lending another £70bn to the Irish government and banks?

Isn't this just a mind-boggling example of a gigantic fiscal transfer between Peter and Paul? And what on Earth would be the point of that?

In other words, it's not just the size of the loan from the EU and IMF to Ireland that matters, but the use to which the money will be put.

Or to put it another way, there's absolutely no sense in propping up Ireland's big ailing banks by injecting new capital into them if they're still regarded by commercial lenders and investors as crocks.

What's required is to establish the losses that Anglo Irish, Allied Irish and Bank of Ireland are yet to incur from their reckless lending to property developers and homeowners.

And there’s also a need to reconstruct and shrink Ireland's banks so that they are substantial enough to meet the credit needs of legitimate borrowers and not so big that when they run into difficulties they risk bankrupting the Irish state (the Irish government has already set in train the dismantling of Anglo Irish).

Without such a reorganisation, the new finance provided by EU and IMF would arguably be throwing a ton of good money after an ocean of bad.

UPDATE 18:18  Actually I'm told by M Sorrell (the chief exec of WPP) that any rise in Ireland's corporation tax rate would not make him relocate WPP to another low-tax centre, for the simple reason that he only pays that low rate on WPP's Irish profits - which are a fraction of this international media group's total profits.

For WPP to want to quit Dublin, the Irish government would have to threaten to tax profits earned outside Ireland by the likes of WPP - which, M Sorrell says, was threatened by the UK's HMRC (and was why WPP went to Dublin in the first place). There's no suggestion right now of the Irish government wishing to do that.

If the same fiscal logic applies to other multinationals that have relocated to Dublin, a rise in Irish corporation tax would be most painful for what you might call proper Irish companies, or those businesses that earn a significant proportion of their profits in Ireland. 

Ireland: The big bail-out is a done deal (almost)

Robert Peston | 09:41 UK time, Thursday, 18 November 2010


Ireland's government is now surrounded.

A woman passes the Department of Finance in Dublin

Its European Union partners want it to accept a substantial rescue loan from the EU and International Monetary Fund - which is likely to include some kind of participation from the UK.

The European Central Bank is urging such a rescue, so that some kind of confidence of commercial lenders can be restored in Ireland's banks - which would help Ireland's banks to begin to repay the £110bn odd they've borrowed in emergency liquidity from the ECB.

Ireland's central bank governor, Patrick Honohan, has this morning said that such a loan, running to tens of billions of euros, is very likely to be accepted.

All of which means that Ireland's taoiseach and finance minister no longer have any room for manoeuvre (some would argue).

Can you imagine circumstances in which the Irish government, whose grip on office is not seen as particularly firm, could go against the urgings and advice of those states and institutions that are the last defence for Ireland against the perception that it is bust?

As I and my colleague Stephanie Flanders have written many times over many months, Ireland has borrowed more than was remotely prudent - some 700% of GDP, when bank debt, state debt, household debt and corporate debt is aggregated.

If Ireland's creditors, many of which have been pulling out their money from Ireland's banks as fast as they can in recent months, are to be reassured that they don't have to demand the rest back - with potentially devastating consequences both for Ireland and the financial integrity of the eurozone - the implicit financial support for Ireland of Germany, France, the UK and other states has to be turned into explicit support. And soon.

Ireland: How much punishment for British and international banks?

Robert Peston | 09:09 UK time, Wednesday, 17 November 2010


Are haircuts in or out for Ireland? Will the putative experts at the IMF, European Commission and European Central Bank, who will spend the next few days examining Ireland’s intertwined banking and fiscal challenges, recommend that there should be losses imposed on the providers of tens of billions of euros of wholesale debt to banks.

EU flag reflected on a window in Dublin


It’s extremely difficult to be sure - which is going to unsettle markets.

This is what finance ministers from the eurozone said in a statement last night:

“We welcome the measures taken to date by Ireland to deal with issues in its banking sector, via guarantees, recapitalisation and asset segregation. These measures have helped to support the Irish banking sector at a time of great dislocation. However, market conditions have not normalised and pressures remain, giving rise to concerns that further reforms and stabilisation measures may be appropriate.”

Or to put it another way, the Irish strategy of using taxpayers money to strengthen the balance sheets of banks - by injecting new capital into them and dumping their worst loans into NAMA’s toxic bin - has only been partly successful. Other measures are needed.

What might those other measures be? Well goodness only knows. The European Commission’s Economic and Monetary Commissioner, Olli Rehn, said there would be an “intensification of a potential programme with an accent on the restructuring of the banking sector”.

It is that phrase “restructuring of the banking sector” which may alarm the banks and financial institutions which are wholesale creditors of Ireland’s banks, the providers of more senior debt which is supposed to be least at risk of non-repayment. The implication is that consideration is being given to forcing losses on them, such that they would share in the costs of rehabilitating Ireland’s banks.

If that were to happen, it would be counter to the passionately stated policies of Ireland’s Taoiseach or prime minister, Brian Cowen, and his finance minster, Brian Lenihan. They fear that reneging on these debts would see Ireland cast out into a financial leper colony, unable to tap new commercial sources of credit for years if not decades (see my post, Why Ireland can’t afford to punish reckless lenders to its banks).

However, and slightly to my surprise, I am told that the European Central Bank is also opposed to imposing losses or haircuts on senior debt holders. If true, this would matter, in that - as I made clear on Monday (see my post, Will the ECB pull the plug on Ireland?) - it is the ECB which is the prime mover in trying to force Ireland to take emergency finance from the EU or IMF, as part of a package to put its banks and public finances on a firmer footing.

That said, it would be a bit odd if the ECB, in the shape of all its senior movers and shakers, were opposed to such haircuts: there is a powerful moral argument, of the sort that normally appeals to central bankers, to the effect that overseas banks and institutions in the UK, Germany and so on should have known better than to encourage Ireland’s banks to lend recklessly and pump up a completely unsustainable property bubble - and that they therefore deserve a bit of a spanking.

What’s more, if Ireland is fundamentally incapable of paying off all it owes - which is equivalent to an oppressive 700% of GDP when banking, public sector and private sector debts are added together -some will say it is grotesquely unfair that the cost should fall entirely on taxpayers in Ireland, the European Union and (if IMF money is drawn) the rest of the world.

All that said, there might be sound practical reasons for protecting the senior debt providers.

Certainly it is very difficult to see - under the current law - how the senior debt holders could be punished in the absence of some dramatic events. First the two weakest of the big banks, Anglo Irish Bank and Allied Irish Banks, would probably have to be declared insolvent. And second, almost all the many billions of euros that Irish taxpayers have already pumped into these banks would have to be written off, which would be extremely painful.

What would then be triggered would be enormous payments by underwriters of credit default swaps (CDSs), the debt insurance contracts taken out by lenders and speculators. These payments would generate enormous losses for the financial institutions, including banks, which provided the CDS cover.


Sources close to the Irish government tell me that the US authorities are deeply concerned at the idea that CDS payments would be triggered in this way. The implication (yet again) is that insurance contracts designed to reduce risk are in fact a source of systemic instability. Which, of course, has been the hideous norm in the Frankenstein markets that have been engineered over the past decade or so.

Even without the CDS loss multiplier, the impact of debt haircuts would be painful for British and international banks. According to the Bank for International Settlements, total lending of non-Irish banks to Irish banks is around $170bn, of which British banks provided $42bn, German banks provided $46bn, US banks $25bn and French banks $21bn.

Which British banks are at risk? Well according to new research by Morgan Stanley, total lending to Ireland’s private and public sectors is equivalent to 92.3% of the net assets of Denmark’s Danske Bank, 89.5% of Royal Bank of Scotland’s net assets, 60.2% of Lloyds’ net assets and 15.9% of Barclays’ net assets. Those figures exclude bank-to-bank lending, but they indicate how exposed Britain’s banks are to Ireland’s woes (RBS is most exposed, as the owner of a substantial Irish bank, Ulster Bank).

What’s more, if there are haircuts imposed on Irish bank debt, it’s very difficult to see how haircuts could be avoided for Greek and Portuguese bank debt too, and also for plain vanilla Irish, Portuguese and Greek government borrowings.

If you add all that together, it comes to $435bn of exposure for international banks to the banking and public sectors of the eurozone’s three weakest economies. If, say, a third of that were written off (enough to make the residual debt almost bearable) that would trigger not far off $150bn of losses for banks alone.

By the way, bigger losses would fall on pension funds, insurers and other financial institutions.

Would that be an unthinkable, unbearable cost for banks, that would undermine the integrity of the financial system? Probably not. Is it understandable that the Irish government doesn’t want to be the first to test whether international banks can take the strain? Probably.

Read the rest of this entry

How big is Europe's crisis?

Robert Peston | 11:27 UK time, Tuesday, 16 November 2010


This morning has felt a bit like a surreal dream.

On the one hand a couple of fairly substantial economies, Ireland and Portugal, are teetering on the brink of collapse.

Jack and Vera Duckworth

A vision of Vera Duckworth

On the other, a raft of results from British businesses - ITV, Easyjet, Burberry, British Land - show that for big companies at least, recovery is real and not as anaemic as statistics for the whole economy imply.

The growth in advertising revenues at ITV, up 16% to £1.25bn in the first nine months of the year, is particularly striking. And if ITV's former chairman, Michael Grade, doesn't point out - and very publicly - that he left ITV in better shape than many have claimed, then I know nothing about the soap opera of the television industry.

Also, the irrepressible Nat Rothschild - he who went to war with George Osborne over who said what in Corfu - is at it again. His new listed mining vehicle, Vallar, is splashing out a short £2bn to buy coal mining assets in Indonesia, which - after a bit of incremental investment - will propel Vallar to membership of the FTSE 100 index.

So the big dogs of commerce are wagging their tails again and looking for prey. The question, of course, is whether the return to growth at larger companies is sustainable, or whether it's a bounce on terrain that is about to crumble.

What the inhabitants of boardrooms will surely have noticed is that the G20 didn't come anywhere near last week to fixing the structural flaws in the global economy - whether those flaws are the unsustainable deficits of developed countries (of which the US is prime exemplar), matched by the equally unsustainable surpluses (many would say) of Germany and China, or treacherous asset bubbles pumped up by abnormally low interest rates and QE in the US and UK.

And what about the woes of Ireland and Portugal? Well, looked at in one way they look trivial for substantial global businesses: the forecast growth (just the growth) in China's nominal GDP of about $1 trillion dollars over the coming year is roughly double the size of the entire combined Irish and Portuguese economies.

So Nat Rothschild would argue, presumably, that what happens to a couple of minor European economies is irrelevant to him - since the coal he'll be producing in Indonesia will be gobbled up by hungry China.

But if, as the EU's president Herman van Rompuy says this morning, it's the very survival of the eurozone that's in the balance, well that's of greater moment - even to China.

One way to gauge the heft of the moment, so to speak, is to look at the total exposures of overseas banks to the banks, private sectors and public sectors of those European economies which have borrowed rather more than they can probably afford to repay.

Here are the relevant numbers: non-domestic bank exposure (that's the exposure of overseas banks to public, private and banking sectors) is around $300bn for Greece, a little bit more for Portugal, and $840bn for Ireland. That's around $1.5 trillion (£930bn) in total, twice the value of the aggregated economies of Greece, Portugal and Ireland, or three-quarters of Britain's GDP.

Let's assume, which is reasonable, that a meaningful portion of that $1.5 trillion can never be repaid, because some part of the collateral backing those loans has been lost forever (property prices, for example, simply won't recover fast enough) and the earning capacity of the Greek, Portuguese and Irish economies isn't enough to meet the difference.

Even so, the potential loss on that $1.5 trillion exposure for banks would be manageable (if painful) so long as there is an orderly process of establishing what can be repaid - and then reconstructing the quantum and payment schedule of the debts on that basis.

What would be a disaster - and this is reflected in the emotional comments of Mr van Rompuy and of Portugal's finance minister, Fernando Teixeira dos Santos - would be a disorderly, piecemeal process of public and private sector defaults, especially since that would be bound to undermine the financial credibility of other much bigger eurozone economies, such as Spain and Italy.

To simplify where we stand, the global financial system has recapitalised sufficiently over the past couple of years to absorb the losses of a controlled workout of the excessive debts in the eurozone's weaker economies - but there would be a serious risk of a new credit crunch, and global recession, if the providers of that $1.5 trillion of credit to Ireland, Portugal and Greece were to lose confidence that there will be a controlled workout and were to ask for their money back now.

Will the ECB pull the plug on Ireland?

Robert Peston | 17:04 UK time, Monday, 15 November 2010


The gap between what Ireland spends on public services and what it receives in tax revenues, the classic public-sector deficit, is substantial and unsustainable, at around 12% of GDP.

A discount shop in Dublin

A discount shop in Dublin

But, funnily enough, that is not Ireland's biggest problem.

Ireland's weakness, what has sparked the pressure from other EU members and the European Commission for some kind of bailout of the Irish state, is its bloated, lossmaking banking system.

The country's banks are largely state controlled, with Bank of Ireland the only substantial Irish bank where the taxpayer shareholding is relatively small.

And yet these banks find it fantastically difficult to borrow from other banks or financial institutions.

The point is that investors and professional lenders are reluctant to lend either to the Irish state directly, by purchasing government bonds, or indirectly, by lending to Irish banks.

And it is their refusal to lend to banks that is the real liquidity crisis for Ireland, in that the Irish government's deficit is fully funded until well into next year.

So it is not an exaggeration to say that there would not be a banking system in Ireland - and therefore not an economy in any conventional sense - if it weren't for the generosity of the European Central Bank in providing loans to Irish banks that the markets won't provide.

The latest published figures, which almost certainly understate the true picture, show that the European Central Bank had lent 83bn euros to Ireland's domestic banks by the end of September and it had lent 130bn euros to all Irish credit institutions at the end of October.

Or to put it another way, ECB loans to Irish financial institutions were more-or-less equivalent to the current annual value of Ireland's Gross National Product.

To repeat, without the financial support of the ECB, Ireland would be bust right now.

According to Barclays Capital, more than 10% of all the loans and investments made by Ireland's banks - their assets - are financed with ECB cash (which looks to me like a bit of an under-estimate).

The important point is that Ireland's banks, and those of Portugal, and even some of Germany's Landesbanks, have been on life support provided by the ECB for many many months now.

So there has already been a European Union rescue of Ireland - and arguably of Portugal too (where some 7.2% of bank assets are financed by the ECB, according to Barcap) - but that rescue has been carried out by the backdoor, by the European Central Bank.

Now standard central banking theology, that goes back to Bagehot in the 1870s, says that central banks are only supposed to provide liquidity support to inherently viable institutions. However the evidence is accumulating that a number of Irish banks are not viable, even after the recent multi-billion euro injections of new capital by Irish taxpayers.

Also, the ECB must be concerned, for example, that Portugal's government may be funding itself by selling government bonds to its banks at a high rate of interest, which in turn may be financing those purchases by borrowing from the ECB at a lower rate of interest. Another article of central banking theology is that central banks should not indirectly recapitalise weak banks or finance over-stretched states.

Which means that the moment is fast approaching when the ECB, if it behaves as many would say a central bank must behave to preserve the value of the currency, will announce that it is phasing out liquidity support for those weaker European banks - in Ireland, and Portugal and even Germany - which have become too dependent on it for loans.

But if the ECB were to be true to its central banking instincts and announced a timetable for removing the life-saving funding drip, what could be done to keep Ireland's banks and economy alive?

The governor of the Central Bank of Ireland, Patrick Honohan, put it like this in evidence last week to Ireland's Joint Committee on Economic Regulatory Affairs: "presumably over-capitalising the banks could help build confidence, but this is not something which the state can be lightly asked to do, given the pressures on its finances".

Arguably, Mr Honohan has given the game away, by saying that investors are taking the view that Ireland's banks need bigger injections of capital from taxpayers, but that Ireland's taxpayers cannot afford to invest any more in the banks.

What follows from that?

Well, it means that if the Irish can be persuaded to take funds either from the European Financial Stability Fund or from the European Financial Stability Mechanism or from the International Monetary Fund, that money should probably be invested in the banks, to provide them with more protection against future losses. As Mr Honohan pointed out, investors don't believe that Irish banks have seen the worst of losses on residential mortgages taken out when Ireland's housing market was booming (them were the days), even if they believe that the worst of the banks' commercial property loans are being shipped out to a taxpayer-backed, specially created toxic bin, the National Asset Management Agency.

This is what it boils down to.

The Irish government does not want a new formal bail out. But if there is the faintest sign that the ECB wants to withdraw the succour it has provided to weak eurozone banks, Ireland will no longer have a choice: it will have to go cap in hand either to its EU partners or to the IMF.

By the way, that choice of whether to go to the EU or IMF will be a nightmarish one for the Irish.

On the one hand, their pronounced communautaire spirit would point them towards Brussels for help; but the IMF is much less likely to bully the Irish government into abandoning cherished pillars of its economic policy, such as its low corporate tax rate (which the German government would dearly love to squish).

And there is one other thing: a conspicuous missing ingredient in the debate about what Ireland should do is about who should shoulder the bulk of the losses in the long run.

Few deny that the Irish state has borrowed far more than it can afford to repay in the form of bank debt, public-sector debt, household debt and corporate debt.

There are going to have to be haircuts and write-offs, big losses, as the debt is shrunk to an affordable size.

The seemingly open question is how those write-offs, those losses, will be shared between Irish taxpayers, European taxpayers and commercial lenders.

Right now, which some will see as unfair, the burden seems to be falling on taxpayers, with the commercial lenders apparently getting off very lightly indeed.

Banks negotiate bonuses pact

Robert Peston | 20:29 UK time, Sunday, 14 November 2010


Britain's biggest banks are talking to each about whether and how they can reduce the total amount of bonuses they would pay in the upcoming bonus season.

I have learned that serious negotiations are taking place on this thorny issue under the umbrella of the British Bankers Association, their trade association.

"We are talking to each other about making some kind of joint statement about bonuses, that would demonstrate that we are reducing the amount we are allocating to remuneration this year" said a senior banker. "It's early days and it's yet not clear whether we will be able to come up with a workable agreement".

Bank bosses know that almost whatever they announce in bonus payments early in the new year will attract criticism from politicians and the public, largely because of the belt tightening that is taking place in the public sector and much of the rest of the economy. However they are trying to limit the criticism.

"What's the most we could achieve?" said a participant in the secret talks. "Well right now the expectation is that banks in the City will pay out around £7bn in bonuses. Maybe we can cut that to £4bn. But although that would be a huge reduction, £4bn is still a big number - and we'll still face attacks".

There are formidable obstacles in the way of any kind of pact on pay.

One great fear of bankers is that they'll be seen to be colluding on a competitive issue, and could therefore be prosecuted by the Office of Fair Trading.

"One of the great paradoxes about all of this is that ministers would love us to agree to cut bonuses, but they're powerless to stop us being prosecuted under competition law," a banker said.

So the bankers in the talks are taking great pains not to be seen to be limiting competition in anything they discuss.

Second they are terrified of reaching an agreement on bonuses that would provide an incentive to top banking talent to relocate to other financial centres, where there are fewer concerns about big pay.

In particular, they are irked that banks on Wall Street are resistant to the idea that they too should agree a policy of mutual disarmament on bonus awards.

"There's no chance that the big US investment banks will follow our example" the banker added. "Which means that business and good people could leave London for New York or elsewhere, if we're seen to be paying less than the market rate".

I disclosed last December that it was opposition from American banks that put the kibosh on short-lived and fairly nebulous talks between international bankers on constraining bonuses that took place a year ago.

The total size of the bonus pool on Wall Street for 2010 performance is expected to be around $20bn (£12.4bn), or about 80 per cent greater than the expected London bonus pool.

Another idea under discussion is that the banks should pool the funds they deploy for community projects and philanthropy, so that they could win some good headlines for allocating hundreds of millions of pounds to good works.

However they're pessimistic this will come to anything, for two reasons.

First, they are reluctant to give up their existing philanthropic projects.

Second, they recognise that if they allocate more money to good causes, they may well be seen to be taking money from their shareholders - including pension funds looking after the savings of millions of people - in order to buy off criticism of huge pay packets going to employees.

"The headlines could actually end up being worse for us, if we did that", another banker said.

G20 is iffy about G-SIFIs

Robert Peston | 09:00 UK time, Friday, 12 November 2010


You may feel that there is quite enough in the way of acronyms and jargon in your life, but I'm afraid to say that I have to introduce you to the concept of the G-SIFI - which would be centre stage at the G20 meeting in Seoul if trade imbalances and flows of hot money from the US to China weren't a source of some cattiness between world leaders.

There has been an outline agreement at Seoul on what to do about those supposedly dangerous G-SIFIs, following a recommendation by the supreme decision-making body of central bankers and regulators - the one that sits above the Basel Committee on Banking Supervision - the Financial Stability Board.

G-SIFIs are "global systemically important financial institutions". They are, to quote the FSB (no, not Russia's internal security agency; wake up!), "firms whose disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity".

Now as luck would have it, the UK boasts more G-SIFIs relative to the size of the UK economy than any other G20 country.

HSBC, Barclays and Royal Bank of Scotland, all of which have assets and liabilities greater than £1.5 trillion (rather bigger than the UK's GDP) and all of which have investment banking, commercial banking and retail banking operations in many countries, are all indubitably G-SIFIs.

Standard Chartered, which is a good deal smaller in respect of assets and liabilities (if not in market value), may be a G-SIFI, because it is so international.

Lloyds, which is a very UK-focussed bank, is probably just a SIFI, rather than a G-SIFI. If it went kaput tomorrow, it could wreck the British economy - but the damage to other economies would probably be indirect (via a potential loss of confidence in other banks) rather than direct.

The big thing about these G-SIFIs, apart from their sheer size and complexity, is that they are supra-national institutions, at a time when the supervision or policing of banks, and insolvency procedures, remain largely national affairs.

This is a recipe for mayhem in markets and economies, were a G-SIFI to go down - which is what we saw in the autumn of 2008, when Lehman Bros died. And it's as well to remember that compared with an RBS or a Barclays, Lehman wasn't a particularly complicated G-SIFI.

That's why, when other G-SIFIs got into serious trouble after the Lehman debacle, none was permitted to go bust: RBS in the UK, Citigroup in the US, UBS in Switzerland, as only the most egregious examples among many, all were bailed out at huge expense by taxpayers.

Or to put it another way, capitalism failed - because those who owned the shares and subordinated debt in these banks, and were rewarded during the good years for the risks being run by these banks, did not pay the appropriate price when the risks went bad.

So what the G20 leaders have endorsed is the outline of a plan that should end the madness of these G-SIFIs and their owners being allowed to do what they like, safe in the knowledge that they're protected by taxpayers if it all goes horribly wrong.

Execution of the plan, however, will be fraught with difficulties.

It requires regulators and supervisors from Beijing to Moscow to London to Washington being equally expert, and intrusive and robust in their dealings with the likes of Goldman Sachs, Deutsche Bank and BNP Paribas.

It requires every major country in the world to harmonise special insolvency or resolutions procedures for banks - which will entail heroic attempts by parliaments in many countries to streamline new bankruptcy laws.

It requires governments and regulators in every major country in the world to legislate so that a massively higher proportion of the liabilities of these G-SIFIs can be converted into loss-absorbing equity in a crisis - and it requires investors to supply these potentially loss-absorbing loans and additional equity without massively increasing the funding costs for banks, which could raise the cost of borrowing for households and businesses.

On this last point, here's an illustration of the scale of the financial challenge. Work by the FSA and Bank of England suggests that perhaps a third of the balance sheets of G-SIFI has to be loss absorbing in the form of pure equity, contingent convertible bonds (CoCos) or bail-in debt, in order to sufficiently shield taxpayers from risks.

That compares with a ratio of core equity to risk-weighted assets of just 7% for smaller, simpler banks, under the new Basel lll rules.

So even if the G-SIFIs are allowed to calculate their assets on a risk-weighted basis when assessing their loss-absorbing needs, it would require the likes of Barclays, RBS and HSBC to raise many tens of billions of pounds of loss-absorbing capital - which will not be cheap or easy for them to do, and which they wouldn't have to do if they weren't G-SIFIs.

Here's what I think is really gripping about the G20 agreement on G-SIFIs: it sets a huge challenge for the boards of G-SIFIs and the owners of G-SIFIs in respect of determining whether the putative financial benefits of being a huge complex international organisation outweigh the new additional costs being imposed on them.

If the G20 countries follow through on their G-SIFI pact, one rational response by the G-SIFIs could be to break themselves up into smaller simpler organisations, to avoid the new capital requirements and the regulatory intrusiveness that will be the other price of being a G-SIFI.

All of which is likely to put the share prices of G-SIFIs under a black cloud for some time, until the precise new cost of remaining a G-SIFI is quantified.

But if you're starting to feel sorry for the G-SIFIs, here's a remedy.

The chairman of a G-SIFI recently confided in me that he could live to be a hundred, and he still wouldn't have a grip on all the risky things that his massive bank does in the nooks and crannies of the financial world.

If he has recently come to the view that his bank and its shareholders would be better off if it was a slimmer, simpler organisation, then it would probably be foolish for governments and regulators to weaken in their resolve to disarm (so to speak) institutions like his that they see as weapons of mass economic destruction.

PS: There is one group of firms which should probably be even more alarmed by today's G20 agreement than the G-SIFIs. They are the credit rating agencies.

Because the G20 leaders have agreed that central banks and regulators should strive - wherever possible - to cease using their formal ratings of debt and institutions in assessing the riskiness of that debt and those institutions.

Bang goes the rating agencies' monopolistic business model.

China: Boom or bust? (2)

Robert Peston | 07:42 UK time, Wednesday, 10 November 2010


Although it's been a trip of 18 hour working days, and hurried noodles at midnight in a 24-hour cafe which (thank goodness) shows live football (though I would have preferred to have missed Flappyarmski v Andy Carroll), I'll miss China and Beijing.

It's a cliche, I know, but it's nonetheless true that it's impossible to take your eyes off the scale of change here, or be unimpressed by it.

Which is why China optimists remain convinced that for all the structural challenges still facing this country - the widening gap between rich and poor, a rapidly ageing population, the tension between growth and environmental protection, and (the theme of much of my work on this trip) growth still too dependent on investment rather than domestic consumption - these challenges will in time be overcome.

Along the way, however, this is a country which has a propensity to take adverse trends close to the brink of disaster.

The pumping up of a residential property bubble, as illustrated by such phenomena as the creation of the peopleless city (see my note on Kangbashi), appears to be one such trend.

This bubble is a consequence of the enrichment of a new and growing middle class facing huge restrictions on where they can invest their money.

With interest rates so low and restrictions on investing abroad, buying new apartments is one of the few investments available to the new monied class.

But here's the thing that appears odd to westerners: many of these property investors prefer to buy these apartments and leave them empty rather than rent them out.


Which is why all over China, as manifested in Kangbashi in extreme form, residential property developments have been sold, but yet remain largely unoccupied.

What will jar in buy-to-let obsessed Britain is that large numbers of apartments can remain vacant in a country where urbanisation, the migration of many millions of impoverished peasants to cities, is one of the so-called mega-trends.

The explanation, according to a Tsinghua University economist, Patrick Chovanec - corroborated by locals - is that Chinese people regard apartments as they would cars: brand new is good and top price; used is bad and lower price.

Apparently, the moment someone moves into a property, its price falls, because it's no longer pristine.

So property investors have little desire or incentive to rent out their properties, because to do so would be to cut the re-sale value. Better to keep them empty in the hope that a rising market will deliver capital gains.

Which means there's nowhere to live for those who have only the means to rent rather than buy - and large (but unquantified) numbers of homes are empty.

In a country where hundreds of millions still live in poverty, this feels like something of a social tragedy, as well as a classic market failure.

There is no hard data on the number of these vacant properties. The best way to gauge it is to travel around almost any urban area and see how few lights are on in new developments (not many).

I am sure that the Chinese authorities would deny that this property bubble is a major social or economic problem. But they have recognised it exists by making it more expensive to borrow to purchase multiple homes.

The good news is that this bubble isn't a banking risk in the sense that it would be in the UK or US. Many, but not all, of these properties have been bought for cash. So if the bubble is popped, there shouldn't be enormous losses for banks that undermine their solvency.

But of course, if the cycle of rising asset prices were to go dramatically into reverse - and there are signs that the froth has already come off the property market - that would cause problems for developers and investors, which could then impair the quality of bank loans.

Anyone who says they know this is a huge accident waiting to happen is going on hunch because - as I say - there is something of a fog around this market.

But it would be myopic or dim to deny that a bubble - and potentially a highly dangerous one - is the inevitable consequence of a historically unprecedented mass movement of personal enrichment combined with severe restrictions on how and where the newly enriched can invest their cash.

Does China's surplus matter?

Robert Peston | 12:12 UK time, Tuesday, 9 November 2010


The first time I heard birdsong on this or any of my trips to Beijing was today, when I interviewed the Chinese Commerce Minister, Chen Deming.

Chen Deming


The interview took place in a magnificent and tranquil government-owned estate, the Diaoyutai state guesthouse - where Britain's Chancellor of the Exchequer, business secretary and energy secretary were holding talks with their Chinese opposite numbers - right in the middle of this crowded noisy city.

In a boardroom the size of a basketball pitch, whose walls are papered in gold and which looks over a willow-fringed lake nourished by bubbling waterfalls, I asked Mr Chen whether he accepted that imbalances - China's substantial surplus and the US deficit in particular - are sources of global economic instability.

As it happens, I asked George Osborne, the Chancellor, the same question last night, when I interviewed him in his perfumed cavernous palace of a Beijing hotel.
No surprise - their answers could not have been more different.

Mr Osborne said he viewed the imbalances as the fundamental cause of the Great Recession of 2008-9. And he added that it was a great priority to reduce the deficits of deficit countries - like the US and UK - and to see a corresponding reduction in the surpluses of countries like China and Germany.

Mr Chen, by contrast, rejected the premise of the question.

Or to put it another way, he refused to accept that China operates an unsustainably large trade surplus.

He pointed out that China actually buys more from many countries in Asia and Africa than its sells to them - which reflects its hunger for commodities and high tech products.

Mr Chen also insisted that as a percentage of GDP China's surplus with the whole world in aggregate is modest - and in so-called "cargo" trade in physical goods is insignificant.

That's as maybe. And certainly there has been a sharp fall in China's current account surplus, from 9.6% of GDP in 2008 according to Goldman Sachs, to a forecast 5.5% this year.

But few would argue that a 5.5% surplus is trivial, because in the boom years before the credit crunch the corollary of large surpluses in China, Germany and Japan was the dangerously rising indebtedness in the US, UK, Ireland and some other mature economies.
So if there is an issue here, according to Mr Chen, it relates to China's trading relationship with one country only.

No prizes for guessing which one: it's the US, whose deficit with China, according to Mr Chen, is greater than China's net deficit with all countries.

Mr Osborne would slightly demur from this view. He thinks that the UK's £17.1bn current account deficit with China is a bit of a problem too.

But the chancellor is probably a bit more optimistic than most US politicians that China's economy is set to be reconstructed over the next few years such that consumption will play a far bigger role in generating growth - which should create valuable new markets for British goods and services, especially for the services in which the UK has a genuine competitive edge (architecture, accounting, insurance, law, education, advertising and so on - and you can whisper the word "banking", if you dare).

On Britain's trading prospects, as it happens, Mr Chen had a few spiky words for UK businesses. British brands are far less familiar to Chinese consumers than Italian and French ones, he said, and need to be promoted much better.

And he was scathing about the alleged inability of British tailors and shirtmakers to export jackets and shirts with short enough sleeves for Chinese men. When he spoke to a British manufacturer about its failure to customise its clothes to suit the typical Chinese man, this manufacturer allegedly said that it expected Chinese economic progress to be accompanied by a lengthening of Chinese arms.

I hope that was an example of official Chinese wit. But Mr Chen's big point, for America - and to a lesser extent for the UK too - is that the American and British governments are largely to blame for their deficits with China.

He says that China wants to buy tons more high tech stuff from both countries, but is prevented by prohibitions on the sale to China of kit that could have a military purpose.

This irks him, because - he says - China wants the hardware and software for peaceful purposes.

He also points out that much of America's deficit is simply the consequence of its own companies outsourcing their production to low-cost China.

Anyway when I raised the question of whether it mightn't be an idea for China's authorities to let the Chinese currency, the Renmimbi, float up a bit more than the 3% or so it has risen against the dollar since the peg was relaxed in June, I received what can only be described as a "stupid boy, Pike" look.

Or to translate for the few of you who've never watched Dad's Army, Mr Chen is adamant that the trade surplus - which he says doesn't exist anyway - would not be eliminated by allowing the Renmimbi to find its natural market level.

All of which rather confirms what Mr Osborne said to me, which is that this week's G20 summit in Korea will make only limited progress on agreeing measures for rectifying the irksome and destabilising imbalances in flows of trade and capital.

So if you happen to think that global economic growth will remain weak and fragile unless and until there is a serious meeting of minds from world leaders on how to eliminate those surpluses and deficits, well you should probably be a bit downcast.

Can the UK close massive deficit with China?

Robert Peston | 15:22 UK time, Sunday, 7 November 2010


To say that the Chinese market represents a huge opportunity for British companies has traditionally been like saying that there would be no water shortage if only we could get the salt out of seawater cheaply - it's been true in theory, and hugely tricky to do in practice.

George Osborne and Li Keqiang


The crude statistics of our trade in goods and services with China tell you most of what you need to know: in 2009 we sold £8.7bn of tangibles and intangibles to China, and we bought three times as much, £25.8bn, from the Chinese.

It's true that UK exports of goods to China rose 44% in the first eight months of 2010 to £4.5bn, but our current account deficit with China is by far the largest deficit we have with any trading partner.

And although over 10 years our sales of goods and services to China have increased by a seemingly healthy 4.6 times, imports have risen by a far greater multiple, 6.6 times.

No British lectures

That said, with the arrival in China of a significant proportion of the British cabinet (chancellor, business secretary, education secretary, energy secretary and prime minister are all coming), as design or luck would have it this may be the moment for British companies to generate significant job-creating sales in China.

When I interviewed Vince Cable in the British Ambassador's Beijing residence earlier today (not too shabby a crib, as my son might say), he insisted that the bilateral deficit with China doesn't bother him - he prefers to see trade in the round, in a multilateral sense.

And Mr Cable insisted he would not be picking up the widespread concerns in the US that the Chinese currency is undervalued: Mr Cable said he had not flown all this way to lecture the Chinese that they should allow the yuan to appreciate against the dollar.

... while in France

So what is the point of this huge ministerial and business mission to Beijing?

Well I suppose that in a China where state-owned enterprises represent a massive proportion of the economy, it probably helps that British ministers are seen to be batting for non state-owned British companies: although I do wonder whether the current sophisticated crop of Chinese ministers and officials genuinely believe that the likes of BP and Rolls-Royce dance to a Whitehall tune.

It's not altogether surprising that when the Chinese president, Hu Jintao, visited France last week, the French president Nicolas Sarkozy claimed the countries had struck £14bn of commercial deals, rather more than Mr Cameron will flaunt: some would say that there is an incestuous relationship between the French state and commerce which is almost Chinese.

Unsustainable economic model

But it's reasonable to be optimistic that UK exports to China will increase because - as the Chinese government concedes - China's economy needs to be reconstructed pretty fundamentally, if the official target of growing at around 8% per annum is to be continued in a sustainable way.

Putting it in the crudest possible terms, the Chinese population of more than 1.3 billion people has to consume more relative to the size of their economy.

Even the Chinese authorities concede that China's current economic model - of growth generated by huge domestic investment and massive net exports helped by an exchange rate that is forcibly held down below where it ought to be - cannot be sustained forever.

Our debt = their surplus

There is of course no consensus between China and America on the urgency of the necessary reforms.

But there is some consensus that the Great Recession of 2008-9 was at least in part caused by the madness of a global economic system in which the net importing western nations, like the US and UK, have taken on crippling indebtedness as the corollary of China's (and Germany's and Japan's) huge surpluses (the dispute between China and America is whether the propensity to borrow created the surpluses, or vice versa).

On that view, the Great Recession was just the first shock - and global economic stability will be illusory unless and until the net exporting nations and net importing ones find an orderly way to achieve balance (which is what the G20 heads of government will agonise about at their summit in Korea at the end of the week).

The Chinese Good Life

Certainly the Chinese seem in little doubt that the massive increase in domestic investment they engineered to restart the economy after it stalled at the end of 2008 is only a short-term fix: it'll seriously hurt the banks which financed the investment unless a market for the output of all the new productive capacity is created at home and abroad.

There is also a much more basic way of seeing the inevitable reconstruction of the Chinese economy towards consumption.

Here in China there is a growing sense that the good life should be about more than just working all hours to supply the trinkets demanded by indebted Brits and Americans.

The Chinese want some cake too.

At the high end of the income scale, they want Beamers and 'S'-class Mercs. Between just June and September, Mercedes sold 41,000 vehicles in China, one in eight of all its car sales, a rate of growth of 140%.

Colossal spending gap

But for most Chinese, it's about much more basic needs.

That is already being reflected - according to the US investment bank Goldman Sachs - in around a third of Chinese GDP growth coming from spending by the household sector in 2010 and 2011, up from 28% three years ago.

In fact Goldman's China economist, Yu Song, thinks the current strength of consumer spending here might mean it delivers 40% of GDP growth.

But that is still about 25 percentage points below the share of consumer spending in the British and American economies.

So the magnitude of the money potentially available to western exporters is colossal.

As Jim O'Neill of Goldman tells me, even now just the growth in China's imports every year is equivalent to the entire output of the Greek economy, or around £250bn.

That's a lot of whisky, and aero-engines and chocolates that could be made in Britain and sold in China.

Update 0800, 8 November: The US has now conceded that there'll be no agreement at the G20 summit on quantitative targets for current account surpluses and deficits.

Which means that there'll be no hardening up of the deal made last month by G20 finance ministers to avoid - in some nebulous sense - long-term current account surpluses and deficits.

That is not a great shock given that the great exporters of Asia, South America and Europe (a big hello to Germany and China) regarded numerical targets as bonkers.

And they opened a new front of criticism against the US, by asserting that the Fed's $600bn of money creation through quantitative easing is degrading the US dollar.

Against that background, it will be fascinating to see what the Chinese commerce minister Chen Deming tells me about the prospects for the G20 Summit, when I interview him tomorrow.

China: boom or bust? (1)

Robert Peston | 13:56 UK time, Friday, 5 November 2010


One day into my trip to China and I'm at that stage where I don't know what to think, partly because I've been bombarded with fascinating and contradictory information, and partly because I'm in a jet-lag induced fog.

So probably best to describe what's been going on, rather than draw hasty conclusions.

In no particular order, here is what I have heard and observed.

Ducks tongue and jelly fish

Robert Peston and statue of Genghis Khan

I've spent several hours in the remarkable new city of Kangbashi in Ordos, Inner Mongolia, which is either an example of amazing long-term investment or the manifestation of an insane Chinese property bubble.

I have never seen anything quite like Kangbashi, a vast urban landscape that has been constructed over the past five years on an arid, scrub-like plain in the middle of nowhere.

The local Communist Party official in charge of attracting investment to the region, Mrs Wang Linxiang, told me it was being built to house one million people within 10 years. That's costing in the order of £15bn a year of investment in the Ordos region - or so she said over a lunch of ducks tongues and jelly fish.

And it looks as though Kangbashi will accomodate not far off a million people already - because there is acre after acre of newly completed or soon-to-be finished residential apartments, office blocks and municipal buildings.

It's the public spaces that are most impressive and put town planning in the UK to shame.

The town centre boasts an opera house, a museum, a library and a stadium, any one of which is probably bigger than their largest UK equivalent.

And although their designs won't be to everyone's taste - the opera house looks like a giant traditional Mongolian hat (think Tommy Cooper fez with Asiatic twist), the museum is an enormous bronze coffee bean - there's no lack of boldness in the architecture.

There's also a square not conspicuously smaller than Tianamen or Place de La Concorde, where there are giant statues celebrating the world-conquering feats of that ambitious Mongol, Genghis Khan.

White elephant or far-sighted?

Hubris or sensible long-term planning?

Mrs Linxiang says that the city today has only 20,000 to 30,000 inhabitants. Which means that its wide avenues are deserted and slightly ghostly, especially at night.

But that doesn't mean they won't fill up in time - although all commercial history would suggest that the developers and property speculators may incur losses before it's a fully functioning urban community (think Canary Wharf times 20).

Migration from countryside to city remains a social and economic necessity in China, if average per capita GDP is to rise significantly from the current level of around £2,500.

And Ordos is a boom region, thanks to its massive reserves of coal and significant gas fields.

So, as I implied at the beginning, I really don't know whether to see Kangbashi as a spectacular speculative white elephant or an astonishing manifestation of what the Chinese combination of enterprise and state planning can achieve.

Ofcom's Sky dilemma

Robert Peston | 09:41 UK time, Thursday, 4 November 2010


Starbucks in Beijing, where I am struggling to establish an internet connection, may or may not be an appropriate place to reflect on the confirmation from Vince Cable that he is asking Ofcom to examine News Corp's offer to buy the 61% of British Sky Broadcasting which it doesn't already own (see my post in September, when I said he would ask for this review by the media regulator).

Sky remote control

I have two thoughts.

First: Ofcom has been put in an intriguing position.

In its regulatory dealings with Sky over the past few years, it has regarded News Corp's existing 39% stake in Sky as giving News Corp control of Sky.

So - some would say - if it is being consistent and rational, it will conclude that increasing the stake from 39% to 100% does not in practice reduce choice or plurality in the media.

Of course, the media groups that want the acquisition looked at - which include the BBC, along with the Telegraph, Mail, Mirror and Guardian - believe that Ofcom's earlier analysis was perhaps too glib.

But their arguments against the takeover look primarily like competition arguments - such as whether News Corp would become a dominant news provider in the UK, too easily able to crush rivals, when endowed with Sky's formidable cash flows and when all News Corp's print and digital titles could be promoted for free on Sky.

These competition issues are not for Ofcom: they are being examined by the European Commission.

The one obvious plurality question relates to Sky News, the news channel owned by BSkyB. If it were integrated with News Corp's newspaper and online titles, then there would be a serious diminution of news "voices".

But under existing prohibitions on editorialising by television news services, it is difficult to see how News Corp could turn Sky News into an audio-visual version of the Sun or Times, even if it wanted to do so.

So, again, it may be that whether News Corp owns 39% or 100% of Sky is irrelevant to Sky News's editorial independence.

That said, I am told that if fears about the separateness and impartiality of Sky News proved to be the stumbling block to the takeover, News Corp would be prepared to sell Sky News - in order to land the fabulous, growing, cash-generating business that is the rest of BSkyB.

My sources for this are credible. But I have to admit to being sceptical that Sky News would be offloaded.

For one thing, Sky News - which is an expensive, lossmaking operation - would not be that easy to sell.

Second, Rupert Murdoch - always a news man, never a luvvie - probably loves Sky News more than any other part of BSkyB.

So it seems unlikely he would enthusiastically offer up the disposal of Sky News.

Lloyds and Santander appointments: A cultural banking revolution

Robert Peston | 11:19 UK time, Wednesday, 3 November 2010


So a super-suave, brainy, Portuguese alumnus of Citibank and Goldman becomes chief executive of Lloyds, the biggest retail bank in Britain.

And a woman (and no, I haven't taken leave of my senses) takes the helm of arguably the second most important retail bank in this country, Santander UK.

Now that's what I call a cultural revolution in the male dominated, staid world of British banking.

Antonio Horta-Osorio, who is 46 and has run all of Santander's UK operations since 2006, will replace Eric Daniels as Lloyds' boss on March 1 next year.

Ana Patricia Botin


And Ana Patricia Botin, daughter of Santander's chairman, Emilio Botin, is to become the new head of Santander UK.

She's widely regarded as a formidable banker. But some will doubtless note that the glass ceiling for female bankers in the UK could only be shattered by the offspring of one of the world's most powerful banking dynasties.

As for the new boss of Lloyds, his track record doesn't look too shabby.

He has been at Santander for 18 years and was on a path to become chief executive of that highly reputed Spanish-based international retail bank in three years.

In his time there, he has created substantial banking operations for Santander in Brazil and Portugal. Acquiring retail banks and integrating them is his forte (he has done that seven times).

In 2006, Horta-Osorio inherited control of a UK bank that used to be called Abbey National (bought by Santander in November 2004), and he subsequently took over the savings and deposits business of Bradford & Bingley and the whole of Alliance & Leicester.

Santander says that even stripping out the impact of the acquisitions, he has achieved double-digit revenue and profits growth during each year of his tenure. And - which can't be said of many banks, and certainly can't be said by Lloyds - there has been unbroken profits growth in every three month period of his time at the helm.

But why on earth is he leaving one of the world's most successful banks, where he was the heir apparent, to run a bank that in the last couple of years has generated mind-boggling losses.

And why would he want to stay in the UK, where the word "banks" and "banker" are almost terms of abuse?

Antonio Horta-Osorio


Well he told me that he and his wife have come to love the UK. He likes the diversity and openness of the UK and regards it as the best place to educate his children.

And, before you ask, that love of this country hasn't been generated by an enormous bag of cash that Lloyds wants to foist on him.

That said, he will be well paid by Lloyds, with a package comparable to that of Stephen Hester, chief executive of Royal Bank of Scotland - so worth many millions of pounds over several years.

But although he will receive some compensation from Lloyds for the Santander share plans he's surrendering, Lloyds insists that he will be losing money on the deal, that his overall remuneration will fall.

What are the potentially big prizes for Lloyds from the recruitment?

Well there are two.

First there's the obvious one, that as and when Lloyds has cut out or cured its stinking loans and investments, he'll finish off the integration of HBOS (bought so controversially by Lloyds in the autumn of 2008) in a way that makes Lloyds as efficient as Santander.

In the UK, Santander's ratio of costs to income is 38%, more than 5 percentage points lower than Lloyds on an underlying basis; and each 1% reduction in Lloyds costs relative to income would generate an additional £250m of profit (or so).

Second, he's probably the best advocate that Lloyds could have at the Banking Commission set up by George Osborne. Or at least that's what Win Bischoff, Lloyds' dapper German chairman, tells me.

The Commission is examining whether Lloyds, with its 30% share of UK current accounts, 24% of mortgages and 23% of small banking services, should be broken up.

What Mr Horta-Osorio will argue, from first hand experience, is that Lloyds' sheer size did not prevent Santander winning significant amounts of new business in the UK - that Lloyds was unable to stifle competition or squish a new competitor in the shape of Santander, which these days is a major player, with more than 10% of the British retail banking market.

Which is relevant evidence for the Commission.

However the Commission will be aware that Lloyds' ability to exploit its substantial market shares to batter rivals may have been constrained by the need for management to first remedy all those poisonous loans that came with HBOS.

And if Mr Horto-Osorio turns out to be as effective a banker as his history suggests he may be, then Lloyds' market power may turn out to be very dangerous indeed for its competitors - and, the Commission may fear, rather better for Lloyds' shareholders than for consumers, as and when the bank is rehabilitated.

UPDATE 1408: Hmmm. Mr Horta-Osorio may be making a financial sacrifice by joining Lloyds, but he's most definitely not doing charity work.

He'll be receiving a base salary of £1.035m base salary, £610,000 in lieu of pension contribution, up to £2.3m in bonus, and a maximum of £4.6m in long term incentives, payable in three years.

So if he hits targets, he could earn up to £8.5m for his performance in his first year.

Oh, and he will receive unspecified compensation for the loss of cash, shares and pension benefits at Santander.

All of which begs the question, since he is making a financial sacrifice to join Lloyds, what on earth was he earning at Santander?

BP and Lloyds: We all pay for their recovery

Robert Peston | 11:27 UK time, Tuesday, 2 November 2010


Perhaps what's most remarkable about Lloyds and BP is not the magnitude of the mess they caused for themselves, their shareholders and many of the rest of us, but how remarkably quickly they have returned to profit - as today's quarterly statements from the wounded corporate giants demonstrate.

BP and Lloyds logos


These businesses have such powerful positions in products and services that consumers can't do without that they simply can't be killed - no matter how much effort they put into self-immolation.

In the case of BP, the recent remarks of its new chief executive Bob Dudley to me, that the company may resume dividend payments in the new year, don't look impetuous.

BP is back in black, to the tune of more than £1bn in the three months to the end of September, in spite of incurring a further $7.7bn (£4.8bn) of charges relating to the Gulf of Mexico oil spill - which brings to almost $40bn (£25bn) the total provision that BP has made for the ultimate costs of the debacle.

It has benefited from a higher oil price, which boosted earnings in its giant exploration and production division by £1.3bn, offsetting a fall in the amount of oil produced.

That division is being broken up, as part of comprehensive efforts by the new chief executive Bob Dudley to rehabilitate this battered business.

His cure also includes shrinking BP, selling off up to $30bn (£19bn) of assets by the end of the year, to cover those huge oil spill costs.

Lloyds' reconstruction also involves major shrinkage - in its case, through reducing the size of its balance sheet by £200bn during the coming three years. That means lending and investing less, though Lloyds insists that customers with whom it has a relationship will not see a diminution in available credit.

On what it does lend, Lloyds, owner of the Halifax, is enjoying higher returns, a widening in the gap between what it charges for loans - especially mortgages - and what it pays for funds.

That interest margin arguably became too thin during the property-bubble years before the credit crunch of 2007. Mortgage banks systematically under-estimated the risks of providing mortgages.

But if borrowers feel grumpy about being charged more to rectify a problem not of their own making, can you blame them?

So the patching up of Lloyds and BP may be the occasion for two cheers rather than the full troika. Because in both cases, rehabilitation involves charging more for selling less, or widening profit margins.

That they are able to widen their margins is reassuring for owners of the businesses (including British taxpayers at Lloyds, and millions of us saving for a pension in both cases).

They'll both argue, of course, that the prices they charge are set and conditioned by competition in their respective market places. But whether through luck or design, prices have moved in their favour.

And because most of us can't avoid borrowing from banks, lending to banks or procuring energy, when they charge more for oil and credit, or cut savings rates, their salvation reduces the spending power of consumers and the investing ability of businesses.

Also when they shed jobs in order to generate more revenue for less overhead - particularly characteristic of Lloyds right now - then the costs of the rescue fall on largely innocent staff.

Which isn't to say that anyone - other than competitors and corporate predators - would benefit from keeping either BP or Lloyds in a chronically weak condition.

But it is to point out that when businesses of the scale and economic importance of Lloyds and BP run into difficulties, it is impossible to limit the costs of the clear up to the holders of risk capital, their shareholders.

It's not just the potential of BP to poison the seas and its role in meeting vital energy needs - or the pivotal role of Lloyds in the payments system, credit creation and the protection of saving - that legitimise ministers and regulators systematically sticking their noses into the affairs of big companies.

Can we be surprised that no major British political party or even an influential faction these days argues for minimalist government? The debate isn't between interventionist left and free-market right: for now at least, it's a dry managerial argument over what kind of intervention works best.

The huge pay gap between public and private companies

Robert Peston | 08:58 UK time, Monday, 1 November 2010


The Institute of Directors has published its annual directors' rewards survey - and the results are possibly not what you would have expected.

The big finding is that the majority of directors across the private sector received a pay cut in real, inflation-adjusted terms in 2010: 46% of directors either had a pay freeze or pay reduction in cash terms in 2010; the 54% who had a pay rise received 2.5% in 2010, which is equivalent to a cut when inflation is taken into account.

Or to put it another way, the pay experience of the majority of private-sector directors is similar to the pay experience of most private-sector employees: there've been slimmish picking over the past year of economic recovery.

So how does that square with the recent authoritative report from Incomes Data Services, which disclosed that FTSE-100 directors saw their total earnings increased by a mouth-watering 55% on average over the past year, while the average increment for the FTSE 350 as a whole was 45%?

Surely the surveys are contradictory? How can it be that one survey shows that directors have almost never ever had it so good and another one shows that they're tightening their belts a notch?

Well the surveys looked at different groups of private-sector bosses.

The Institute of Directors analyses the pay and bonuses of more than 1,500 directors of large unlisted companies plus small and medium size enterprises (SMEs). Incomes Data Services trawls through the remuneration of substantial companies listed on the stock market.

What the two surveys have disclosed is a massive difference between what those at the top of big public companies receive, or companies that are largely owned by institutional investors, and the rewards of bosses of privately owned businesses, where those bosses are often the owners as well as the managers.

What could explain this stunning contrast between the FTSE-100 executive class and the owner-manager class?

A number of possible explanations suggest themselves.

One is that many smaller private companies continue to find business conditions challenging, either for want of demand for their goods or services or - more contentiously - for want of adequate supply of finance from the FTSE-100 banks.

Certainly, it's been relatively easy for big sprawling listed companies to cut costs and overheads to boost margins during the downturn, and thus to engineer a profits recovery during this mild economic recovery, whereas smaller companies that started with fewer employees and less fat have found it harder to increase efficiency.

Apart from anything else, big companies have the size and muscle to derive gains by forcing their suppliers to cut prices (as shown by the furore highlighted in yesterday's Telegraph over Serco's demand - now withdrawn - for a 2.5% rebate from its suppliers); smaller businesses lower down the food chain simply don't have that opportunity.

But it is also probable that what we're witnessing in the pay disparity is another manifestation of the agency problem: irrational decision-making at listed companies which stems from the gap at listed companies between owners and managers.

Let's make the assumption - which is largely born out by the economic data - that most private-sector companies, whether privately owned or publicly-listed, are enjoying some kind of recovery.

In those circumstances it may still be rational for directors of those companies to take only modest pay rises: it may be prudent to conserve as much cash as possible in the business, given that the outlook is uncertain; or it may be sensible to align the pay experience of those at the top with the pay experience of employees and the wider British workforce, to improve morale and foster cohesion in the workplace.

That may be blindingly obvious to those who own and manage businesses, because there's no escape for them from those businesses; their one chance for personal prosperity is the survival and growth of their respective companies over many years.

But chief executives on contract at FTSE-100 companies are in a different position; as hired guns, it is rational for them - if not necessarily for their companies - to pocket as much as possible as quickly as possible from pay, bonuses, share options and long-term incentive plans.

Which of course is why for the past 20-odd years there have been endless attempts, through corporate governance codes and remuneration reforms, to more closely align the interests of publicly-company bosses with owners.

Even so, the central discussion on most FTSE-100 remuneration committees, which set the pay of FTSE-100 bosses, is about what their respective companies have to pay their senior executives to prevent those senior executives defecting to rivals.

That means FTSE-100 pay is driven to a large extent by the dynamics of a so-called talent market, which seems to operate in a way that is semi-detached from the performance of the public companies themselves.

But if the market rate for FTSE-100 executives is a 54% pay rise, while more-or-less everyone else is seeing their pay reduced in real terms, then some are arguing that the market is an ass.

It would probably not be healthy for the economic prospects of the UK if most FTSE-100 companies suffered the kind of reputational damage from the way they pay their top people that has so harmed the public standing of our biggest banks as a result of the big bonuses they've been paying.

But since those who sit on remuneration committees are themselves beneficiaries of a pay system founded on the Rooney/Toure principle that the going rate is all that matters, it's not altogether surprising that the wider public interest does not seem to operate in boardroom negotiations on compensation.

Public companies have of course been put on warning about all this by the Business Secretary, Vince Cable, who has launched a sweeping corporate governance review that will take in the question of whether FTSE-100 executives pay is excessive.

Mr Cable will find it difficult to ignore the yawning remuneration gap between large public companies, which represent the immediate past of the British economy, and the smaller private businesses which the prime minister has identified again today as the UK's best hope for a prosperous future.

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