Tuesday, 30 September 2008

The Big Bail Out, Round 2

I was up quite early this morning and decided to conduct an (entirely unscientific) investigation into mass panic. Before retiring to my hugely comfortable bed yesterday news had come through that The Big Bail Out had fallen on stony ground. Wall Street was a-crumbling and those who like to spend other people's money were complaining left right and centre. It was no surprise that the BBC was dragging in all its favourite doomsayers to opine upon the airwaves, and still less of a surprise that they felt they knew better than the people with responsibility to take the decision. So today I decided to follow the BBC radio news all day and see what pattern emerged.

This morning there appeared to be no wail unwailed and no tooth ungnashed as the doomsayers predicted the end of the world as we know it. It being the BBC, most of them made that prediction with glee. Many seemed to take obvious delight at having a new reason for abhoring the capitalist economic structure now that their former ammunition, global warming, has turned into global cooling. The west cannot survive, they crowed, without fundamental change. Only state control of banks can ensure bounty for all, thank goodness we have the supreme wisdom of Gordon Brown to lead the world at this pivotal moment. Thank goodness I had some Marmite on toast to keep me calm in the face of this feeble minded lunacy.

By the time my breakfast teapot was empty the London Stock Market was trading well. The collapse wished upon it by the BBC's finest guests was nowhere to be seen. By 10am a new set of doomsayers were being paraded. They had consulted the doomsayers' manual which advises them to use failure of the first prediction as evidence that things are even worse than previously feared. Just wait, they said, when Wall Street gets going there will be banks falling aplenty. Gordon Brown was brought out again: "doing the right thing", "global problem", "getting on with the job", "difficult times", "world stage", "experience". Yesterday the BBC spent much time promoting Gordon as the brains behind The Big Bail Out and the message had to be rammed home again today. There is a central message on the BBC today, Gordon is in charge and he has the answer.

Recovery in the stock markets continued, suggestions were coming forward for market-led measures to alleviate the problem (I got these from the internet, of course, not the BBC) and noises from across the pond were that things had calmed considerably. The message arrived that American taxpayers were not exactly cock-a-hoop about throwing vast sums of money at wealthy bankers when it was the bankers' bad decisions which had caused the mess. It became clear that a deal will be done in the next few days but it will be one the incumbent Congressmen can sell to their constituents (not a minor consideration when the whole House of Representatives is up for re-election in four weeks' time). The banks will be saved. Mass panic was over and the BBC turned to damage limitation mode.

Oh dear, poor doomsayers. Mid afternoon the BBC ditched them and turned to cementing Gordon's supposed reputation. A special interview was recorded and played widely. Just the same as he said earlier except that now it is the revised Big Bail Out for which he must be thanked. There's a lot of "we" in the interview, as though the man has been involved. He has not. He has been sitting on the sidelines giving interviews while the Americans responsible for the decisions have been busy discussing options among themselves. You would never guess that from listening to the BBC.

My mind goes back twelve months to last year's Conservative Party Conference. Poor gauche Gordon, the Marxist idealist who considers the Conservative Party to be Hitler in a blue suit, is such an obsessive, bigotted and downright rude man that he could not abide by convention. Convention requires each party to keep quiet while one of the other parties is holding its annual conference. The reasoning behind it is simple. No one has a monopoly on good ideas and democratic government requires the people to have a chance to hear what everyone has to say. For one week and one week only the opposition parties have greater access to the airwaves than throughout the rest of the year and, of course, the governing party also has a week in the spotlight. It is only one week for each opposition party, the rest of the time they are in the background as the government's decisions and proposals are aired. But Gordon is not a fair man. He is deeply spiteful. Any chance to cause trouble for his opponents is music to his ears, so last year he decided to drop into Iraq during the Conservative Conference and seek to grab some headlines for himself. It backfired hugely because it showed even those favourable to him what a devious and nasty piece of work he is, so uncertain of his own abilities that he feels the need to drown out dissent.

This week he is doing the same. He has no business being in Washington. Neither the White House nor Capitol Hill asked him to visit and neither is consulting him. It is a pure stunt to divert attention from the Conservatives. As always, the BBC backs Gordon all the way so he gets lots of airtime and even more supportive editorial comment.

Today was a fine example of mass panic as an excuse to display prejudices. Positions harden when the chips are down. That is why the Americans are ignoring Gordon, there is no benefit to them from pretending to consult a man who has bankrupted the Treasury he has commanded for eleven years. It is also why the BBC has mounted an all-out campaign to promote him. As a keen listener I have noticed increasing concern among BBC radio hacks in recent months as the polls have shown ever increasing Conservative leads. They were desperate for an excuse to close down coverage of the Conservative Conference and place Gordon centre stage.

Panic over, The Big Bail Out will become The Big Stringent Loan With Painful Consequences For Bad Bankers. Gordon will claim credit, the BBC will give Gordon credit and it will take up to three months for his empty position to be exposed fully. As always, panic brings out prejudices and, as always, prejudices come back to haunt those with a duty to be impartial.

The Big Bail Out, Round 1

Now here's a thought.

America's bankers seem to want a bail-out from the taxpayer for the consequences of their shabby lending and even shabbier use of worthless mortgages as security for cycle after cycle of further lending. Let them have a bail-out, but let them take a chunk of the risk themselves. We know it is not all the bankers' fault because the US government forced them to make many of the bad loans, so let's apportion blame 50-50.

I suggest that, in addition to the banks themselves being in hock for the money paid, every two dollars paid to a bank must be matched by personal guarantees worth one dollar from the directors of the banks (and their spouses, no hiding behind the petticoat by putting the yacht in Mrs Banker's name). No personal guarantees, no money. If a bank looks like it might fold and affect a hedge fund badly, let the directors of the hedge fund join in and mortgage their houses to the taxpayer. No free ride boys. Pay to play.

Members of the liberal intelligentsia are all over the radio this evening denouncing the idiotic members of Congress for not supporting the bail-out plan, but this is to misunderstand the American mind-set. If something goes wrong they presume someone is at fault. It has its downside (McDonalds and hot coffee come to mind) but it also has a massive upside. Bad business decisions are visited upon many an executive and greedy decisions in which the truth is masked from customers often result in long prison sentences, even where there is no direct deception. It's all a matter of personal responsibility. The bigger the earner, the more he is held to account for bad decisions which hit the little man hard.

A package of some kind will go through, but not before the right balance is struck between the risk taken by the taxpayer and the risk borne by those with most to gain.

Thursday, 25 September 2008

The Purple Peril turn to shares

It has been a fine day for ludicrous utterings from the seriously ignorant. I will not waste my stubby fingers on the moronic trade union dinosaur on Question Time this evening, but the Archbishops of York and Canterbury deserve mention. Canterbury has called for short-selling to be outlawed and York called those who engaged in it "bank robbers and asset strippers". It really is mind-boggling. Not quite as mind-boggling as Gordon Brown's reference to "short-term sales", but mind-boggling nonetheless. Let's look at the basics using baked beans as an example.

Mr Bloggins wants to set up business making baked beans. He has a recipe which results in hugely tasty baked beans so he wants to make them in bulk, tin them and sell them. Mr Bloggins needs a factory and machinery but he cannot afford to buy them for cash. He could borrow the necessary money but an ordinary loan requires regular repayments of interest and he might not be able to establish steady sales for some time, so he cannot raise a loan. He decides to invite people to invest in his new business by offering them the chance to share in future profits. He needs £1million so he asks one million people to put £1 each into the pot. Because he cannot guarantee when, if ever, a profit will be made all he can offer is the chance of sharing in profits in the future. Spreading the cost of raising £1million in capital by selling shares means each investor only pays £1 so the most they can lose is £1 each. In return for their £1 investment they are given a piece of paper giving them each a 1,000,000th share in the value of the company.

The value of the company is determined by the value of its assets. The factory and machinery have a value and so does the future profit from selling baked beans. All the time only £1million has been raised from investors. If the value of the Bloggins Baked Bean Company rises to £3million because the land the factory is sited on has risen in value or sales of beans are very strong, each share goes up in value to £3. If the value of the company's assets falls, so does the value of each share because each share is necessarily worth one millionth of the value of the company's assets.

Some investors will want to hold on to their shares forever in the hope of steady profits from sales of the flatulence inducing product but others might wish to withdraw their money and invest it elsewhere. A market starts in the shares and the value of the company's assets determines the price of each share. Except that no one really knows the value of the company's assets, it can only ever be estimated. Changes to land values and changes to the likely future demand for tinned baked beans will determine how much people are prepared to pay for shares. If it is anticipated that the business might hit troubled times, perhaps through the threat of an EU tax on methane inducing products, holders of shares will want to sell them before they fall in value and buyers will only be prepared to buy if the price is right. Today the threat to the business might justify a 10% reduction in price, tomorrow some good news might justify an increase of 20%. It is often thought that shares have a value of their own but they do not, they are merely a reflection of the value of the company.

Short selling is all about anticipating a fall in the value of a company. If shares are priced at £3 today and you think they will fall to £2 because the company is in trouble you want to sell for £3 and then buy later for £2. If you already own shares it is easy, you just sell what you have, take the money and then buy once the price is £2. If you do not own shares in the company you can borrow someone else's shares, sell them and then buy back later and hand the newly bought shares to the person you borrowed from. You pay him a fee for allowing you to borrow his shares and you pocket the balance of profit. This is short selling: borrowing shares so you can sell them now and buying later so you can hand the correct number back to the lender. There are various theories about where the term "short selling" came from but the most compelling is that the person who wishes to sell does not have any shares, he is short of shares, he borrows so that he can sell even though he is short of shares himself.

Short selling is a very risky business. You sell at £3 expecting a fall to £2 but instead the value rises to £16.50. Your lender demands the return of 1,000 shares in the Bloggins Baked Bean Company and you must deliver so you have to buy at £16.50. The sale brought you £3,000 and buying replacements costs you £16,500. Ouch.

Short selling can also induce a collapse in the value of shares. All of a sudden instead of the average turnover of, say, 1,000 Bloggins Beans shares each day there are 200,000 for sale. People ask why. It looks as though a lot of people think Bloggins Beans is in trouble and the price falls through the floor. Even if Bloggins beans is highly profitable it appears that people think it will not continue to be profitable which can cause problems for Bloggins Beans itself (for example it might find credit hard to come by) and for other holders of shares in the company. People who have used shares in Bloggins Beans as security for a loan find their lender calling in the debt because there is now insufficient security. Investments based on the capital value of shares rather than dividend receipts produce lower returns and so it can go on. In other words, short selling can become a self-fulfilling prophesy.

The only valid criticism of short selling is that it can artificially deflate the value of shares and that can have knock-on effects. However, this can only happen in the short term where the company in question is strong. The other side of the coin is that short-selling can bring to light little known weaknesses in a business. Enron's shares started to fall as a result of a spate of short selling after rumours circulated about its accounting practices. Those rumours were true and the effect of short selling was entirely beneficial - a business based on deceit was brought to its knees thereby preventing future losses on an even grander scale than those resulting from Enron's collapse.

Where a sector of the economy is under pressure there is an argument for preventing the short selling of shares in that sector so that it has a chance to find its feet again (if it can) without the threat of an artificial downward force on its share prices. That is why the shares in a number of UK banks and other financial institutions are subject to a ban on short selling at the moment. Banning the practice completely will merely delay the day failing companies are exposed, and the knock-on effects of that are far worse than the limited consequences of a sound company being artificially undervalued for a limited period.

As for those who engage in short selling being "bank robbers and asset strippers", that comment merely shows the Archbishop of York to be ludicrously naive. Like so many men who spend their working lives in fancy frocks, he is best kept well away from the real world. Let him hold his shepherd's crook and pontificate about his god all he wants, then tell him him his stipend and eventual pension come from the profits the Church of England makes on the stock exchange. I wait with baited breath to hear that he will repay every penny he has received over the years from the profits of short selling.

What's wrong with being wrong?

Once, but only once, I heard someone say "I am never wrong" and mean it. He was the father of a boy in my class at primary school and you could never meet a more ignorant man in your life. Nothing about his existence gave rise to praise. He was uneducated, rude and vulgar, beat his wife and treated his children like slaves, indeed beat his children and treated his wife like a slave. Because I knew one of his sons I encountered him occasionally and learned how lucky I was to have my parents as parents rather than a pig-headed fool like him. More than anything else it was his "I am never wrong" comment that affected me because it was said in answer to a question my friend asked him. "What's the capital of America Dad?" "New York". My friend's mother chipped in with "I think it's Washington" and the look from husband to wife was a mixture of fear and hatred. Fear that his dominance would be challenged and hatred of being exposed as an ignoramus. Had I not been there she would have got another beating, maybe she did after I went home. "It's New York" he snarled "I'm never wrong."

That memory sticks in my mind because I knew he was wrong. In those days children of eight or nine learned the major capital cities. And I could not believe that someone who was wrong could assert with a threatening swagger that he was right. In our house a question asked of either parent might be answered with assurance but if the answer was questioned someone got out the encyclopaedia and we all read the relevant entry. There was no shame in being wrong, instead there was delight in being able to discard ignorance and replace it with fact.

We all make mistakes, some factual and some of judgment. We learn and improve by being corrected. For reasons I do not understand, being wrong is now seen in some quarters as shameful.

Apprenticeships for skilled jobs like bricklaying and plumbing used to take five or seven years. No more than half that time was concerned with teaching the technical skills, the rest was about how to correct your mistakes. The apprentices were not being patronised by being told they will make mistakes, they were being taught a vital lesson in life. If you make a mistake which affects someone else you need to know how to put things right. It's far easier to walk away from an error than to face it and correct it, but when your livelihood depends on the outcome of your work a failure to put things right will disqualify you from future employment. What will not only disqualify you from future employment but lead to a claim for compensation is a stubborn refusal to admit that anything is wrong, even when the brick wall falls down or the new pipework leaks as soon as the water supply is turned on.

Judges make mistakes. That is why we have a Court of Appeal. The judges who have their decisions overturned all have great experience in the law. I came across a couple of duffers who simply weren't up to it, but only a couple. The vast majority have many years of successful practice behind them and work with great dedication to decide cases as fairly as they can, yet still their decisions are overturned. It does not make them incompetent it just illustrates that, like everyone else, they make mistakes. Judges in the Court of Appeal get things wrong and are overturned by the Law Lords sitting in our highest court. Even the Law Lords occasionally get something wrong and have to reverse one of their previous decisions. This must be put in context. They are people of staggering intellectual ability and vast experience and still sometimes their judgment is at fault. There is nothing wrong with that, it is all part of the advancement of learning.

In my junior years in the law I sometimes wondered how judges coped with having a decision overturned by the Court of Appeal. As I got older and had personal friends who were judges I found out from the horse's mouth. They don't like it but they also hear appeals from lower courts and sometimes overturn those decisions. They know it is not a personal insult, it is just an aspect of ordinary life. We all make mistakes. They go to court again the next day, learn from what the Court of Appeal said and continue doing the best they can.

Too many politicians think it necessary to defend bad decisions long after they have been proved to be bad. They think it would be a sign of weakness if they did otherwise. How wrong they are. Admitting errors and taking the necessary steps to correct them is a sign of strength not a sign of weakness.

Margaret Thatcher was not good at admitting errors, in fact I cannot readily recall her ever doing so. That was a major part of her downfall. John Major admitted the error of entering the European Exchange Rate Mechanism and, having done so, was able to rebuild the economy together Kenneth Clarke as Chancellor. More than once Tony Blair shrugged his shoulders during an interview and admitted a policy mistake, saying it seemed likely to work and having the courage to admit it didn't. Many would say he made far more mistakes he has not acknowledged, and that might well be true, but at least he admitted some.

The present incumbent has never made a mistake in his life, according to him. It is his single greatest weakness. Everything that has gone wrong in the last year has been the fault of someone or something other than Gordon Brown, or so he claims. Credit bubble leading to recession? That's the naughty banks' fault for lending too much money, not his fault for encouraging them to do so and still less his fault for doing exactly the same. Energy crisis? That's the fault of the naughty oil companies, not his fault for spending taxpayers' money on gimmicks rather than power stations.

Not everything wrong in Britain is directly Gordon Brown's fault. Some things are, however, and the longer he denies it the more pitiful he becomes. His speech to the Labour conference yesterday was his final chance to act like a human being. Instead, as his party risks sinking below the political waterline, there was no "yes we got this that and the other wrong, but we have corrected those mistakes by doing these things right" it was all "I got it right all along, trust me". I was reminded of the vile father of my childhood friend. The man who was always right in his own mind was almost always wrong in the real world.

The man who is always right in his own mind is an ignorant bully, always has been and always will be.

Monday, 22 September 2008

"A pretty united cabinet"

The heading I have chosen for this little exercise in blogology is Gordon Brown's description of his top table. It strikes me as a quite extraordinary thing for a Prime Minister to say but from the mouth of the current incumbent I suspect it has a special meaning.

At the heart of cabinet government is the concept of collective responsibility. This does not require all members of the cabinet to agree that the collective decision is right but it requires them all to defend every such decision in public no matter how furiously they might argue against it in private. If they feel unable to do so they must resign from the cabinet. These days there does not seem to be much recognisable cabinet government going on but there is still a cabinet and its loyalty to the Prime Minister is crucial to his survival in office.

The principle of collective responsibility allows the Prime Minister of the day to say with absolute confidence that his cabinet is united. In order to be a cabinet it is, by definition, united. For a Prime Minister to say his cabinet is "pretty united" is curious indeed. So why did he say it?

Was it a rare moment of honesty from a man with an 11-year record of dishonesty in his public utterances? Was it a weary slip of the tongue? Was it an exasperated recognition of pending revolt? Of course I do not know what it was other than a very strange thing for a Prime Minister to say. My guess is that it was the best gloss he could put on the truth, if so the next couple of months should be very interesting.

And what do you mean by that?

I like words because they allow communication and the dissemination of knowledge. Like many beneficial things, they can be put to sinister use and I do not just mean as a method of incitement or to form a malicious plot. One of the most sinister uses of words is by obfuscation through jargon and unnecessary complexity or obscurity of language. There you have an example, I said obfuscation. My regular reader might well know what it means but many a man on the Clapham omnibus will not and will assume I mean something really complicated because I have used a long word. In fact I could have omitted it entirely and just said "one of the most sinister uses of words is through jargon and unnecessary complexity or obscurity of language". By adding the clever big word I was able to make my meaning less clear to anyone not familiar with the word itself.

Obscuring what one means can be a sensible thing in the right context. Faced with a nervous patient a doctor might wish to buy time before breaking bad news, gently softening the patient up until he can be told it is necessary to chop his legs off without the reaction being whooping hysteria. A judge might say to a lawyer "I fully understand why that point is of such importance to your client, now what do you say about this ..." He really means "what you have just said is nonsense, let's get to the heart of the matter". This is done not to spare the lawyer's delicate feelings but those of his client who hears every word and takes solace from the judge's apparent empathy without realising he is consigning the client's most cherished argument to the rubbish bin. Examples can be given from many field of true meaning being obscured in order to prevent upset or insult, it is a useful tool to maintain friendly relations pending the time the brutal truth is exposed.

All too often, however, jargon or evasion is used for no apparent reason. We have just had a magnificent example in the US Treasury Secretary telling us he is taking steps to address the problem of banks having "illiquid assets". What he means is banks have vast amounts of bad debt on their books because they lent money when they should not have done and he is going to cover their losses. There is no benefit in calling bad debts "illiquid assets" it is just an unnecessary use of jargon to try to pretend things are not as bad as they are, but the cat is already out of the bag and trying to stuff it back in with jargon does nobody any good it just makes him look shifty and manipulative.

Getting the balance right between plain speaking and techno-babble seems beyond the ability of almost all politicians. Every week there seem to be examples of a high-ranking member of one party or another using an obscure term when simplicity would be better, or dressing something up in jargon when the unvarnished truth would advance his case, or being too blunt when a blow really should be cushioned, or using a meaningless catchphrase which traps him for years ahead.

Take the old cabinet minister Nick Brown, some will remember him as a member of Tony Blair's first cabinet. He was not a very good performer in front of the cameras and put the final nail in his time at the top table when asked whether he would take a particular step to solve a problem. His answer was "it is outwith my powers", a phrase he repeated several times. I sat watching my television and asking why he used that phrase, years later I still do not know. Bad use of language made him appear a pompous fool; exit one ministerial career stage left.

Speaking in clear and simple terms so that people can readily understand what you mean should always be the default position. After all, if you are asking people to trust you to govern the country the very least they can expect is that you will tell them what you plan to do using words they can identify. The fewer times you obfuscate the more you are likely to be trusted and the more you spout meaningless jargon the less you appear to know what you are talking about. Will they learn? I doubt it, but it would be nice to see them try.

Sunday, 21 September 2008

Mind your own business Hazel

There is a long-established tradition that the governments of the UK and the USA do not comment on forthcoming elections in the other country. It is a sensible tradition because, generally speaking, we are on the same side and the new Prime Minister or President will have to work with his opposite number across the Atlantic. A sure recipe for a rocky relationship is the knowledge that the person you have to work with wanted you to lose.

No surprise then that Labour has openly supported Mr Obama. It started with the Prime Minister who issued a statement praising Obama's policy platform, naturally he said it was not him when challenged by the McCain team but no head has rolled so we know he was, yet again, lying to escape the consequences of an error of judgment. Then Labour's deputy leader, Harriet Harman, criticised Mrs Palin on Question Time. Poor Harriet is such an arrogant woman she thinks she is above the rules in every sphere. And most recently the utterly pathetic Hazel Blears joined in, seeking to justify herself by saying the Democratic Party is Labour's sister party.

The only example I can recall of an incumbent American President doing something similar was when the moveable feast of slime that is Bill Clinton was less than flattering about John Major in the run up to the 1997 general election.

What is so curious is that they feel it necessary to give an opinion when it is remarkably easy to keep to the rules. If asked about a candidate you say "the election in the USA is a matter for the American people, I am sure we can work well with whoever they choose". If asked to comment on policy in the other country you say "it is not for me to comment on the policies put forward by the candidates". So simple, all it takes is a little respect for the right of the voters to make their choice. One thing is certain, for every American swayed by an endorsement there will be at least one determined to give the interfering Brits a bloody nose. Or is it curious?

A feature of politics of the left is that it is a mission to change things for the better by government activity. Taking decisions for other people is absolutely at the heart of their philosophy. Politics of the right is, or should be, based on the belief that people should be left to take their own decisions and government should decide as little as possible for them. Against that background it is, perhaps, not surprising that someone mired in a bog of "I know what's best for you" thinking will carry that view into every area. As usual it will do their cause more harm than good.

Friday, 19 September 2008

The big bail-out

The fun and games continue. Now the US government has decided to bail out its troubled banks by, in effect, paying them the value of the bad loans which have caused such a problem. One might wonder how banks have got into this mess. Their business is to make a profit from lending money not to make a massive loss, so what has gone wrong and what can be done to ensure it does not happen again?

My regular reader knows I have a bee in my bonnet about bad lending to house buyers. It is based on experience I gained in the 1990s dealing with many dozens of cases brought by banks, building societies and tertiary lenders against solicitors and valuers. When the housing market slumped and people defaulted on their mortgage repayments the lenders took hit after hit, total losses were so large that they wanted to find someone to share the misery. So they instructed their lawyers to investigate the transactions and see if they could find a mistake by anyone other than the lender. There were two obvious targets, the surveyor or estate agent who gave the lender a valuation and the solicitor who dealt with the conveyancing. These people would have insurance and if a claim could be substantiated all or part of the loss could be recouped. I acted only for lenders in these cases and saw numerous examples of purely speculative lending, particularly from the new players in the market who attracted business by being prepared to advance substantial sums to those the established banks would not touch.

The greatest scandal was lending purely on the basis of a valuation of the house or flat being bought. The borrower did not have to provide either a deposit or proof of his income. It was known as self certification: "I Joe Smith certify that I earn £20,000pa and am able to repay a loan of £80,000." Provided the valuation of the property was at least £80,000 it was "thank you Joe, loan approved, enjoy your new home" and they might have added "for as long as you can afford it".

Established bank and building society lending practice was to require a substantial deposit (between 15% and 25% of the value of the property), to require clearly documented proof of income and to lend only a small multiple of the borrower's current annual income. Such a restrictive basis of lending necessarily excludes many people who would like to own a house but the banks and building societies are not in the business of enabling people to buy houses they are in the business of lending money for a profit. By definition, they could only make a profit from a loan where the capital was repaid with interest, therefore they only advanced money to people who appeared to be likely to be able to pay. A substantial deposit was an indication that the borrowers were prudent people who had saved money. Documented proof of income was an indication of the ability of the borrowers to repay. Restricting the loan to a small multiple of income was an indication that the repayments would be affordable. None was conclusive proof of anything, each was just an indication without which no loan would be made. Even when all those requirements were met, the bank or building society would only lend money if the manager responsible recommended the making of the advance. Many an application was refused because a bank manager had doubts about the viability of the business employing the applicant or concerns that the applicant had expensive tastes and habits which might take priority over paying the mortgage.

It is no coincidence that commercial lending operates on the same basis as the old practice for mortgage lending. When a business wants to borrow money to buy a new factory the first consideration for the bank is the state of the business not the value of the factory. "I want to buy the empty factory in the Balls Pond Road, it is worth £1million. Here is a piece of paper on which I have written that my business makes a profit of £250,000 a year from the manufacture of snow shoes for scuba divers. Will you lend me the money please?" No bank is going to entertain the possibility of lending money let alone get a valuation on the factory, use its own belief that the premises will be worth an extra £300,000 in five years time and make a loan without further enquiry. Loans to businesses are made only on seeing a business plan, detailed accounts for previous years, the current order book and evidence of the likely future market. If it is snow shoes for scuba divers the conclusion will be that there is no market because scuba divers do not buy snow shoes and that will be that, application declined.

Why is it that commercial lending and old-style mortgage lending concentrate on the ability to repay? It is obvious, that is where banks make their money. The value of the property (be it house, flat or factory) is not sufficient justification to make a loan, only the apparent ability of the borrower to make the lender a profit by paying interest is a sufficient justification for making a loan. Having a property as security is necessary to give the bank protection in the event that the borrower does not repay. Security is taken as a damage limitation exercise and for no other purpose.

The new-style mortgage lending of the 1980s in which deposits were small or non-existent and assessments of the applicants' ability to pay were virtually nonexistent was a recipe for disaster. True though it is that disaster would be averted for so long as repayments were made and repossessed properties could be sold for a large enough sum to redeem the loan and cover both accrued interest and costs of repossession and sale, there was still a problem. That problem is that levels of default and repossession were bound to be higher than for loans made following the old-style practice. To compensate for this interest rates charged on self-certified mortgages were higher in the hope that the amount received from those who did pay would balance the lack of profitability from the defaulting loans. It worked very well until the higher interest rates led to even greater levels of default.

Nothing in this analysis of lax 1980s lending practices is complicated. It is all plain and obvious. What is perhaps not so obvious is how they managed to get away with it. The loosest practices were adopted by newcomers to the mortgage lending business, not the established banks and building societies. Such companies did not take deposits from individuals the way banks and building societies do, they had to raise loans from investment banks. Those banks needed to be satisfied that they would be repaid and, sometimes, required security for the massive advances they made. One might think they would have investigated the lending practices in detail but they did not, they too were swept along on the hysteria of ever-rising house prices. And while prices were going up there was ample equity in repossessed houses to repay the capital plus outstanding interest plus the costs of repossession and sale, all the time good profit was being made from the loans that did perform. There was also a factor operating in the background that hid much of the problem, securitisation.

Securitisation is a long word for selling debts. Selling debts is shorthand for selling the right to receive money in the future. There is nothing unrealistic about people being prepared to pay a lump sum now in return for the chance of receiving more in the future. The difficulty arises when a load of debts are packaged in a bundle and sold as one. Some will be good debts with a high chance of being repaid, some will be complete rubbish that are bound to default quickly, what matters is the balance - how many good, how many rubbish? When thousands of mortgage loans are included in a single bundle scrutiny is impossible. Adding more bad debts does not make scrutiny any easier. Bundles of debts are sold over and over, split, amalgamated, split again, merged with another bundle and sold on and on. At each turn the purchaser has a smaller and smaller chance of being able to value what he is buying. So why does he buy? Because others are buying. And why are they buying? Because others are buying. And what determines the price? A general perception of the value of houses, it is nothing specific, it is not based on investigation of the loans included in the bundle. Loans backed by English houses sell well while the English property market rises and while others are buying such loans yet more will want to climb on the bandwagon.

Like most things in life, turmoil in the financial markets is usually based on something pretty simple. The current troubles are caused by one thing and one thing only, a decade of lending money to people who cannot afford to repay it. The collapse in the property market does not cause the problem it merely brings it to light. Bundling huge numbers of loans together in a securitisation process does not cause the problem it just obscures it from view.

It is bad business to lend money to someone who cannot prove his ability to repay. When hundreds of thousands of such loans are made you end up with a week like this week. Lenders did not learn their lesson from the fall-out of the 1989-1991 property crash, now they must learn. Forget pretending to be a branch of social services providing what people want and concentrate on running your business properly. Lend only to those who, on credible evidence, appear able to repay you. Prices will then reflect the true value of the houses and flats on the market and there will be no toxic waste in securitised loans.

How expert is an expert?

We are forever having the opinions of experts thrust at us on television, radio and the internet. Experts are very useful to those making programmes for popular consumption because they stifle debate. Once an expert has pronounced there is no need for the presenter to explain, the expert's word is law. But then a problem arises because a debates is presented between experts. What a curious concept, one might think, if they are experts they must know the truth, therefore what are they debating?

The reality is that an expert is simply someone who is believed (or believes himself) to know more about a subject than the person to whom he is offering his opinion. In some fields expertise comprises knowledge of facts, for example the cricket scorer and statistician Bill Frindall stores vast amount of information about past international cricket matches in his head and is, therefore, an expert in that area of factual knowledge. Not all expertise is based on knowledge of facts, however, some is based on physical skills (Kevin Petersen is an expert batsman), some on the ability to interpret information in order to predict what is likely to happen in the future (Sir Ian Botham is an expert on how a cricket pitch will play during a match) and some on the ability to guide others to take a path of benefit to them (Peter Moores is an expert cricket coach). Keeping with the cricket theme, there are many other expert batsmen, pitch interpreters and coaches none of whom will agree with any of the three I have named about everything. They are all experts because expertise does not give total knowledge or a monopoly of wisdom.

A week ago I gave my "take" on the trial of those accused of criminal damage of a power station (would add a link but don't know how). In the comments someone questioned whether two "expert" witnesses should have been allowed to give evidence. The general rule is that an expert witness can be called where the case involves an issue which cannot be decided without assistance from someone with specialist knowledge or skills which the judge or jury is unlikely to have (this is a gross generalisation, there are many ifs and buts). A simple illustration could be a case in which a solicitor is accused of having made a mistake when undertaking a conveyancing transaction. If the trial is heard by a jury it would be normal for an experienced solicitor to be called to explain how conveyancing should be done whereas a judge would not require such assistance.

No special paper qualifications are needed to be an expert in court, knowledge or skill acquired through experience can be enough. Perhaps the best example I know of an expert without formal qualifications is the astronomer Sir Patrick Moore, some of his work has been at the forefront of his science for decades yet he had no university degree when he started writing and broadcasting. The absence of a piece of paper with a crest on it and the signature of a Vice-Chancellor did not stop his maps of the moon being used by NASA during the Apollo space programme.

Sometimes the finest paper qualifications in the country are no bar to someone being completely wrong in the area to which he has dedicated his life's work. Professor Sir Roy Meadow was pre-eminent in the field of infant death. He identified a syndrome which led to children being killed by those with care of them and a number of people were convicted of murder on the basis of his expert evidence. His theory also led to countless children being removed from their parents and placed in care. Meadow's expertise was not in a matter of knowledge or facts, like cricket statistics, but in the interpretation of facts. His personal expertise was no stronger than the theory he promulgated. On that theory being discredited thoroughly, so was he; having caused immeasurable suffering to others. There was no evidence that he acted through spite or said things he did not believe, it is just that his pet theory was his life. It became a personal obsession such that he was unable to accept any criticism of it. He knew he was right, he knew he was doing good, he knew there was no doubt.

The late actor and raconteur Kenneth Williams often made a quip about experts who concentrate and refine their specialisation so that over time they "know more and more about less and less". This can be a very good thing in the right hands and result in groundbreaking and beneficial advances in many fields. In the wrong hands it can turn expertise into a dangerous obsession with the expert being placed on a pedestal and critics being dismissed as unqualified to challenge the great man or corrupt through envy.

Meadows was finally undone by a single answer he gave in evidence. When asked the probability of there being two accidental infant deaths (often referred to as "cot deaths") in the same family he gave the figure 73,000,000:1. This was such a startling statistic that it raised eyebrows in many quarters and was the start of the eventual total unravelling of his theory, his reputation and his career. Those convicted on his evidence alone were released if still in prison but the children taken from their parents had grown up or settled with a new family, for them it was too late to put right the wrong that had been done to them.

It is rather a strange concept that one person's theory could have such wide-spread consequences, although not so strange when one looks at the context. Sudden infant deaths have occurred for as long as anyone can remember. Baby was put to bed and died. No one knew why, yet it was such a highly emotive topic that everyone wanted an explanation. If there was an identified cause it might be possible to do something to prevent it happening to another family and even if the cause was not preventable at least we would know what it was. Roy Meadow filled the void. His theory was plausible and could not be positively disproved, it became the accepted knowledge which made it even harder to disprove. With every child taken away and every mother or nanny convicted of murder he was given more support, the court accepted the theory therefore it was no longer just a theory it had been proved to be true. But it was not true, it was just another of the thousands of false theories thrown up in science over the years.

Beware the single-issue expert with a pet theory.

Thursday, 18 September 2008

Is there a benefits trap?

It seems to be accepted wisdom that some people living on benefits are trapped by their dependency on welfare. As I understand it two situations exemplify the benefits trap: (i) those who could not earn as much as they receive from the State and (ii) those who could earn a little more but so little that it is not worth the effort. Commonly the latter category are seen as less worthy than the former because they would receive a modest financial gain by working rather than sitting around the house. Little discussion surfaces from the political parties about the former category, it seems to be accepted that because they cannot earn more than they get on welfare so they are justified in remaining on benefits. From time to time suggestions are made about having to undertake some modest form of work to retain an entitlement to benefits, but such suggestions bear all the hallmarks of headline grabbing sops to the taxpayer rather than anything substantive.

My question is: what about those who do work for less than they could get on benefits? Because, you see, there are people like that. Some have always been in very low paid work and others have seen better times but through illness or bad luck find their opportunities restricted. What distinguishes these people from the worthy welfareists, why is it that they choose to work when a cushier option is available? It seems obvious to me that it is all a matter of personal standards. The same explains why some people on low incomes steal things and others say they would rather be poor but proud than engage in dishonesty. It also explains why council estates contain many houses with well tended gardens and clean curtains in the window while others are just storage areas for junk. The standards we have, usually learned from our parents, dictate much of our behaviour and they set the scene for how we live our lives.

The benefits trap is only a trap for those for those who wish to use it as an excuse for idleness. It is certainly a ridiculous state of affairs that anyone should receive so much in State handouts that it could be said to be a disincentive to self-support, but it is wrong to believe that it is a disincentive. It is nothing of the sort unless you choose to treat it as such. Until someone can persuade me that sitting around doing nothing should be the default position and work is just an optional extra, I will not accept that the benefit trap exists at all.

We can look at the position from a different angle. Take the person who would receive, say, £25 more a week on welfare compared to the amount he could earn for the work available to him. Just looking at that sad statistic only tells part of the story. Once he is in work and has a record for honest toil he is better placed to find something that pays more or to seek a raise. Those of us who live in the real world know that employers often take someone on at the minimum wage to undertake a menial task and then increase that person's pay, often through a loyalty bonus or a birthday or Christmas gift, it happens in small businesses up and down the country. The going rate for the job is still the minimum wage but the person doing it with dedication receives a little more. The so-called benefit trap is not a trap at all when one takes into account the increased opportunities that being in work provides. Some will not be able to turn any of those opportunities into more cash, but I can be sure they go home each evening with a great sense of self-worth because they have done a day's work.

It is not the money that traps people on benefits it is their personal attitude, the standards they set for themselves. Any attempt to tackle the problem of the long-term unemployed with no qualifications and no drive must address the issue of standards and then the issue of money will disappear.

Wednesday, 17 September 2008

Today it is AIG's turn

So now the US government has decided to save the insurer AIG from imminent collapse. AIG is one of the insurers most deeply exposed to the toxic waste of bad loans. Yesterday I waffled on about Lehman Brothers, concentrating on one particularly problematic aspect of their business. Today we see another consequence of bad lending.

There are various ways in which insurance companies provide cover to banks and other commercial lenders, the most common of which is to agree to pay part of a loan if the borrower fails to do so. In return for a premium the insurer will pay out a certain amount if a loan is called in and there is a shortfall after the security for the loan has been realised. This type of insurance was often taken out by mortgage lenders, when it was known as Mortgage Indemnity insurance. The standard practice was for the lender to have a limit to the amount it would be prepared to advance, usually 75% or 80% of the value of the property, but to extend that to 90% or even 100% provided the extra sum borrowed was insured. For example, on a property valued at £150,000 the usual maximum loan would be £120,000 (80%) but the borrower would be allowed to borrow the additional £30,000 provided he paid for that £30,000 to be insured.

The trick was to get the premium right. While the market was rising steadily it was money for jam for the insurers because there would rarely be a shortfall. The £150,000 property would go up 10 or 15% in a year; default after two years and the increase in value would be enough to absorb the costs of repossession and sale and the fact that less than a full market price would be achieved on a forced sale. The insurers were falling over themselves to attract business from the lenders and had to offer lower and lower premiums in order to get that business. To an extent it did not matter to the bank how much the premium was because the borrower was required to pay it, but if one bank's insurance cost £1,000 and another's cost £200, it is pretty clear where the borrowers would go.

There came a stage in the mid 1980s when the insurers did not really treat this type of business as insurance at all. They perceived such a low risk of claims that it was just free money. Then came the crash and an inevitable juxtaposition between chickens and roost. Premiums charged over the boom period had averaged between 3% and 5% of the sum insured, £900-£1,500 to borrow an extra £30,000 and get the money needed to buy. The borrower would be required to pay the premium but the insurance was for the benefit of the lender not the borrower. On the borrower defaulting the lender would repossess the house, sell it and claim against the insurance company if there was a shortfall.

The property crash of 1989-1992 saw insurers having to pay out on a lot of claims. One might think that premiums averaging something like 4% of the sums insured would have provided sufficient funds to meet all possible claims, but these were the very riskiest of loans. Out of the premium income the insurance company had to pay its operating expenses leaving at most 2% or 3% in the kitty, call it 2.5% if the money was invested well. It only takes one in forty to default before all net receipts have to be paid out, one in forty-one and a loss is made. That was the position of some insurers in the early 1990s. Of course it was only part of their business but the great storm of 1987 drained huge resources and economic downturns have a funny way of causing a lot of failing shops and factories to catch fire, when times are hard people also do not renew what they consider to be unnecessary insurance or reduce their level of cover.

AIG has been caught by an extraordinary level of default in both business and mortgage loans triggering claims by banks, and this against a background of substantial claims in other areas. Unlike Lehman Brothers, AIG's business was not skewed towards high risk areas, they just happened to be caught by circumstances. The decision of the US government to bail them out with a loan of $85billion (yes, that is billion) was perhaps inevitable given the reach of AIG across a vast area of the American economy. The damage done by collapse could have been far worse than the cost of rescue.

Time will tell whether the bail-out will prove to be a good move. What is certain is the risk to the American taxpayer is far less than it would have been in bailing-out a bank because the businesses, and the bail-outs, work in opposite ways.

Banks take money and pay interest, they have to use the money they take to earn the interest they pay. They get into trouble when the interest they earn is less than the aggregate of the cost of running the bank and the interest they pay their customers. Government support does not increase the profit the bank can make on its investments but it does provide a cushion for such time as costs and interest paid amount to more than interest earned. As we are seeing with Northern Rock, that cushion can be very large and stuffed to the gills with £50 notes. Until such time as the business is profitable the cushion just gets fatter and fatter. There is nothing the government can do to increase revenue and decrease costs, it is just a guarantor of bad debt.

Insurance companies, on the other hand, take money in return for a promise to pay a certain amount in the event that some problem occurs causing a claim. The presence of government backing cannot increase the number of valid claims or increase the sum payable on each claim but it can increase premium income because the customer knows that, in the unlikely event he has a claim, his claim is guaranteed to be paid. He cannot be assured of that from other insurers because they could go belly-up at any time. Customers can easily be persuaded to pay a slightly higher premium in return for the guarantee of payment when they make a valid claim. All it takes is a small tightening of the terms of insurance, so that fewer risks are insured or risks are insured for smaller sums, combined with payment of slightly higher premiums, and the business is back afloat without the taxpayer being exposed to a long-term risk. In the meantime claims will be paid while premiums are insufficient and the Treasury loan has been made to cover that position.

The American government is not stupid. It has taken a massive controlling interest in AIG and will correct the imbalance in its business, if it can be corrected, within a year or two. At that time it will sell off it's interest, probably in stages, and make a massive profit. There is no guarantee, but it is a pretty sound proposition.

Our government, on the other hand, is having to wind-down Northern Rock slowly, turning it from a big player in the mortgage market into a small regional bank. The property market will be tight for a long time and the core of Northern Rock's previous business cannot be recovered. There is no means to make the profit necessary to repay the Treasury in the short term and once it is stabilised as a secure bank it will have to be sold. A massive overall loss to the taxpayer is assured.

Tuesday, 16 September 2008

Dave, be nice to Nick

Nick Clegg is in a strange position. As leader of the country's third political party he knows he has no chance of winning a general election and becoming Prime Minister, yet he also knows that a close result might leave neither of the major parties with a majority in Parliament so he could have considerable power by offering his MPs' support to one side or the other in return for a few policy concessions. As things stand today the prospect of a hung Parliament seems very unlikely, but you never know.

This week the Liberal Democrats are meeting and some interesting changes seem to be afoot. A party which has argued strenuously for higher taxation over the last decade now appears to be changing tack. It is hard to tell exactly what is going on because poor Mr Clegg is walking from one twisted knicker situation into another. One day he is going to reduce taxation, the next day there will be no overall reduction; one day he is going to cut government expenditure by £20bn a year, the next day he only thinking about it; one day income tax will be cut for the poor, the next day it is unaffordable. What one can discern as a distant vision through the dense yellow fog is that the general attitude at the top of the LibDem's is changing. Not long ago it was unthinkable for the leader even to hint at tax cuts and a reining-in of government spending, that we are getting confused hints now is a move in the right direction.

It is particularly interesting to see how this is being reported in the mainstream press because that has a significant effect on public perception. Generally the position is being put forward that the LibDems are proposing reductions in tax for those at the lowest end of the income scale and that it will be paid for by cutting unnecessary bureaucracy. It seems to me that this is part of a general realignment of all three parties in the light of the country going fast down the economic drain. Any realignment is likely to be very bad news for Labour, very good news for the Conservatives and could hit the LibDems either way.

The reason I am confident that it will be bad for Labour is that they can only move one way, back to their natural Marxist philosophical ground. For ten years Tony Blair was able to keep a lid on ranting lefty rhetoric. Of course the occasional dinosaur would surface from the bog, let out a large burp and then descend again, but on the whole the message he was able to send was that old-style interventionist economic management of the type that brought the country to its knees in the 1970s was a thing of the past. Many of us believe the tax and spend approach poor Gordon adopted when at Number 11 was little different from traditional old-Labour policy, especially when combined with the crippling red tape rolled out from Brussels and gleefully wrapped around the throats of British businesses by our government. But that was not the message being received by the public. The message was that Mr Blair's government was committed to the market economy. Now that opinion polls suggest Labour is facing annihilation in the ballot box it must show itself to be different from the alternatives in order to have any chance of saving its skin. The only path open to it is a move back to overt socialist economic management. In my view that is a recipe for a long spell in opposition.

The Conservatives, on the other hand, have spent the last three years projecting themselves as the new friendly and fluffy party. Just as Blair's smarmy charm worked so well electorally, so David Cameron's cheerful moderation and espousal of trendy do-gooding has hit a chord. No longer is his the nasty party, now it is just as cuddly and caring as Mr Blair's Labour. It is all a matter of image, of course. Because an election is approaching it is necessary for Mr Cameron to be much more specific about what he would actually do. He has played the "I'm a nice guy" card very well and, as part of that strategy, has adopted some curiously unconservative policy proposals in order to woo popular support. Any policy necessarily only woos popular support, however, while that policy is popular.

All the "vote blue go green" piffle of the local elections worked well while people thought man-made global warming to be both a reality and something they could change. Now that the theory behind it is facing increasingly strong challenges and the price of doing something about it would hit our way of life very hard, the game is changing. The game is changing in many other areas too because there is irritation at ever increasing taxes, disappointment at only marginally improving health care, despair at the inability of government to provide good education for all, disgust at snouts in the quango trough, frustration about increased official snooping and a realisation that the government has encouraged us all to live on a bubble of unaffordable credit. The default position has changed from even eighteen months ago. Instead of the government being seen to be credible and on our side it has become the architect of economic pain and social discomfort. How true the old perception was and how true the new perception is are beside the point because it is the prevailing perception which determines how new policy announcements will be received.

This time last year we witnessed a quite extraordinary event. The economy was already slowing, house prices were starting to fall and a little nervousness was in the air, yet still the government was holding up well in opinion polls even after ten years in power. Then George Osborne gave his speech at the Conservative Party conference promising a massive increase in the Inheritance Tax threshold and suddenly the mood changed. Almost immediately opinion polls swung heavily in favour of Mr Cameron and since then the floundering Prime Minister has been unable to say or do anything other than make matters worse for him and his party. But that does not mean that one speech could ever be enough to win an election. The question still remained whether the underlying public mood in favour of high government spending would surface again as the election approaches.

Against that background, reports that Mr Clegg's LibDems feel the need to cut taxes and government spending are highly significant. The significance is nothing to do with getting the LibDems into power, it is all to do with the mood of the country, because it helps to shape the underlying general perception of the right course to follow. Few will believe that cutting taxes and spending will ever be favoured by Labour, so if both opposition parties agree that it is the right course to follow it can only add to the anti-Labour sentiment. The more that sentiment becomes a prevailing opinion, the more people will wish to vote not just against Labour but for a possible alternative government. When a mood forms for change, protest votes get squeezed and practicalities take over.

Whatever one might think of the Liberal Democrats, they are a major party and received votes at the last election far greater than their representation in Parliament reflects (almost six million votes, 22% of those cast). This was by far their best result in a general election for many decades and included a large element of protest votes, people disenchanted with Labour but not persuaded by the Conservatives.

With Mr Clegg and his colleagues giving approval to a central Conservative Party principle they have, I believe, helped to tip the mood firmly in favour of the Conservatives as well as strengthening the anti-Labour sentiment. Time will tell whether continued economic upheaval will allow Mr Cameron to go as far as many of us would like, but I am fairly sure he will put both the green stuff and his promises to match Labour spending targets on the back burner and concentrate on creating clear water between his party and a thoroughly discredited government. He must remember to be polite and write a thank you letter to Mr Clegg.

Collapsing banks, what's the problem?

So another bank has gone to the great counting house in the sky, this time Lehman Brothers. The thrusting young men in red braces will draw fat bonuses no more. Does it matter?

The starting point must be to investigate why this bank went under. That is fairly simple, it had obligations to pay money but no money with which to pay them. Although it is dressed up as a mysterious business comprehensible only to the brilliant, investment banking is pretty straight forward. Customers hand over a lump of cash and and the bank invests it hither and yon in the hope that a profit will ensue. The customer receives some of the profit and the bank receives its cut. Everyone is happy and the world continues to turn. Of course they won't attract many customers by saying "hand over cash and we'll try to make it grow", so they offer incentives such as a minimum rate of return over a given period. The customer must leave his money with them for a minimum time. At the end of that period the banks must not only make sufficient profit to be able to pay the customer his guaranteed interest they also have to repay the capital sum if the customer demands it. Some do and others decide to leave it in place for another year or two.

When times are good there are always new investors so those who withdraw their lump sum can be repaid from the lump sums brought in from new business. This encourages the investment banks to take out some very long term investments with the money they manage. Having secured funds from customers who invest for one or two years, they lend that money to others over ten or fifteen years. Because there are always new customers to replace those who withdraw, it is safe for them to "borrow short and lend long". The problem comes when the economy takes a downturn. Instead of, say, one customer in every three withdrawing their money at the end of a one year deal, two in three demand repayment because they need it for other things, and replacement business does not come along to fill the void because potential customers are wary to tie-up funds when they know they might need them. Unless the bank can get its hands on cash it has nothing with which to repay its customers. Of course they do not only lend long they also take out short-term investments which can be cashed-in to provide money at relatively short notice, they hold some money in low interest rate accounts allowing very quick withdrawal and they can borrow from other banks; the key to remaining alive is to have sufficient ability to repay your customers when they demand it.

An investment bank which does not balance its investments correctly can be caught out by being unable to repay its customers. That is what happened to Northern Rock and it is what happened to Lehman Brothers. Too much long lending and an inability to borrow from other banks made them unable to repay their customers. Once there is a hint of this happening, other banks will not only be reluctant to lend to get them out of the hole but they will call-in outstanding loans if they can in order to protect their own businesses. Inevitably when people hear that a bank is in trouble they want to get their money out as quickly as possible and that is so for other banks just as it is for individuals. Those tied into fixed term deals cannot do so unless there is a get-out clause, which there often is at a price of so-many months interest and panicking customers are happy to pay £500 in lost interest where the alternative is losing far more.

In theory there should not be a problem because the funds deposited by customers have been invested and those investments can be used as collateral for a loan from another bank. But, as we saw with Northern Rock, unless the long-term investments are sound they do not provide sufficiently strong collateral for another bank to be prepared to lend. This is why there was so much discussion about the "quality" of Northern Rock's investments. They had lent far too much to people who could not afford to repay them and the houses and flats against which mortgage loans were secured were starting to lose value. Negative equity for the householder is also negative equity for the bank holding a mortgage over the property. A combination of too many weak long-term investments, a general tightening of credit (so that other banks would only lend against very strong security) and a demand by customers for repayment results in the available cash running out and the business going under.

That is all pretty basic stuff, what is more difficult is the effect the collapse of one bank might have on the whole banking sector. It is inevitable that other banks will be affected because some customers will apply a no smoke without fire analysis and keep their cash under the bed instead, but that will not cause any real problems unless a vast number do it. What can cause a real problem is continuing unwillingness for banks to lend to each other. Banking is a very fluid business, the most enormous sums go in and out of banks every day. At the end of the trading day a bank which has received a lot will want to get a return on that money before it is placed in longer term investments so they lend it to other banks who need a bit more to meet liabilities before they, in turn, have a day giving them an overnight surplus. All banks are affected by this so they lend to each other, sometimes many millions of pounds for a very short time, but it needs to be done to ensure surplus funds provide a return and a shortfall can be financed by borrowing. A general lack of confidence between banks can upset this process with the result that all banks become excessively cautious and businesses find it difficult to borrow to fund progress. Almost overnight we can find commercial credit becoming scarce and major projects being delayed or cancelled because there is no way of funding them.

Is that a reason to bail out a bank like Northern Rock or Lehman Brothers? I cannot see why it should be. After all the problem with Northern Rock did not go away when it was nationalised, it still had a rotten investment portfolio and Lehman Brothers would not suddenly become a sound business simply on receipt of taxpayer subsidies. The problems leading to collapse are too deep seated to be solved quickly by a one-off injection of cash from the treasury; structural change is required, which takes time and, as we are seeing with Northern Rock, time used in that process is very expensive time indeed.

Banks must be treated like any other business. If they are run well they will make a profit, if they are run badly they will fold. Far better to let all banks know that their fate is in their own hands, only in that way will they have a proper incentive to lend wisely. After all, banking collapses are almost always caused by bad lending decisions.

Monday, 15 September 2008

It's President McCain (I think)

This year's Presidential election in America is warming up into a rather interesting contest. The primaries were keenly fought among a pretty good list of candidates and it became clear early on that John McCain was likely to win his party's nomination. The Democratic Party fight went to the wire and that, I believe, gives a strong clue to the likely winner in November. I will return to that point shortly, but first I want to explain what I see as the most important battle grounds over the next two months.

It is often said that the most important issue in a presidential election is the economy ("it's the economy, stupid", as Bill Clinton is reported to have said) but that is not to say that it is always crucial. An incumbent president seeking re-election will have difficulties if the economy is in tatters but neither McCain nor Obama is responsible for current problems. Indeed, America seems to be coping with the consequences of the credit crunch rather better than other countries and the sense of deep gloom across the UK is not matched on the other side of the pond. The candidates have a difference of emphasis in their economic policies but there is no stark difference of substance, so I do not see their positions on the economy as something of great importance. Far more significant, I believe, will be health care, McCain's age and Obama's pigmentation.

Health care is a major policy matter this year because it featured so prominently in the Democratic primary campaigns. It was all over the television, radio and newspaper coverage and featured highly in debates. Had it not done so it would probably be a peripheral issue as in almost all previous elections. Now that it has prominence it is the issue on which the main difference between the candidates' approaches can be judged. McCain is adamantly opposed to a national health service funded out of taxes because he knows such systems, as in the UK, are hopelessly inefficient and wasteful and far too open to short-term knee-jerk political interference. He proposes continuance of the insurance-based system but with greater availability at affordable premiums for the least wealthy. Obama has changed his position and has now adopted the Hillary Clinton NHS plan. I believe this will be a real weakness for Obama because what he is proposing will have to sit alongside the existing health insurance structure. It will be seen that, in effect, he is proposing a tax funded NHS only for the poor which will have to be paid for by those already paying their own insurance premiums. That is not a recipe of great appeal to the American mindset.

McCain's age is an issue because he has suffered medical problems and might be unable to see through a full four-year term. Therefore the light is on his running mate to a far greater extent than would normally be the case. Remember that George Bush senior won the race in 1988 despite having the hopeless Dan Quayle on the ticket. In that election the great strengths of the Democratic vice-presidential candidate, Loyd Benson, could not rescue the inadequacies of Michael Dukakis for the top job. McCain's choice of Sarah Palin will prove to be either inspired or disastrous, it is too early yet to say which. What can be said is that Obama opting for Joe Biden was almost certainly a serious error of judgment. In a year when the vice-presidency is of special importance the last person to be chosen should be someone with a long history of foot-in-mouth disease. On the evidence so far Palin is likely to stick to the script, Biden is unlikely to do so.

The other respect in which McCain's age is relevant is simply by way of contrast to Obama's youth. Neither has ever run anything significant, Senators do not run things, they are like backbench MPs. However, McCain has been in national politics for a long time and has had plenty of opportunities to make serious gaffes. Because he has not made any serious enough to prevent his party nominating him he is seen as a safe pair of hands whereas Obama is a very new boy indeed. No one knows how he will react under pressure.

Kennedy got away with youth and inexperience through a combination of ostensible charm and a father who bought votes in sufficient number to sway swing States his son's way. It should not be forgotten that the questions about the legitimacy of Kennedy's win in 1960 were far greater than the dispute about hanging chads in 2000. His opponent, Richard Nixon (you might have heard of him) was urged by many in his party to challenge the result but he had the good sense not to do so for fear that it would suggest he wanted Washington rather than the people to decide the outcome of the election. Eight years later Nixon was in the White House. By contrast Al Gore was completely broken as a national politician by his failed challenge to the outcome in key states in 2000 because he knew he would forever be haunted by his sulking speech of concession.

Unlike Kennedy, Obama does not have a quasi mafia to manipulate votes. Also unlike Kennedy, Obama is not the first white-toothed, youthful charmer to stand. Kennedy had that privilege and turned out to be a disaster as President. When the chips were down his lack of experience and untested judgment combined to cause a series of decisions which blighted his country for years, the intervension in Vietnam being by far the worst. People have long memories and many will see too much of Kennedy in Obama. Interestingly, the oldest man to win a presidential election is also within memory of many, Ronald Reagan; now revered as one of the greatest presidents. I can see a lot of votes being influenced by the negative for Obama of being too Kennedyesque and the positive for McCain of being somewhat Reaganlike.

The final issue I consider of particular importance is Obama's skin colour. It will not be referred to by McCain except as an irrelevance but his words will not change the entrenched views of millions of Americans. Like it or not, America is a deeply conservative country, built with huge success by white settlers a very large number of whose descendants consider it important to have a white president. The question is often asked "is America ready for a black president?". Much of America is, but the rest also have votes.

In America, seemingly more so that in the UK, electioneering is as much about getting your dedicated supporters into the voting booth as it is about pulling undecideds into your camp. As the campaign proceeds over the next seven weeks scrutiny of the candidates will increase in intensity to a level far beyond anything that has been seen so far. In this age of 24-hour television everything they said during their push for nomination has been recorded and each side has a full library of these recordings. In addition, the things their opponents said during the primaries are stored, and ready for use. Many snippets will be brought out and given wide publicity.

This is where I believe the long and bitter contest between Obama and Clinton will be of greatest influence. While McCain was keeping his head down and travelling quietly round the country shaking hands and making generalised speeches, Obama was in the spotlight changing his position on issues to combat a good Clinton speech and being accused of every degree of incompetence and duplicity by a former First Lady. We can be in no doubt that his changes of policy and her strident criticisms will be aired by the McCain team with ruthless efficiency. They will also bring up Obama's tour of Europe which was played-out like a victory celebration. That sort of thing does not go down well in America, just as Neil Kinnock's victory rally in Sheffield in 1992 tipped the election in favour of John Major's Conservatives. Presuming to tell the electorate how they will vote is an expensive ploy.

Once it was clear that Obama and Clinton would be fighting for months while McCain was engaging in the rubber chicken circuit I predicted a McCain victory. Nothing that has happened since then has changed my mind and the clips of Obama flip-flopping and Clinton saying he is an incompetent and a liar will, I believe, seal his fate.

Saturday, 13 September 2008

The "Paralympics". This has to be said ...

No one else has the guts, so I will say it: the Paralympics are a grotesque and patronising freak show.

I can just about understand the wheelchair races, they are no more absurd than someone throwing himself down a steep ice channel on a tea tray in the Winter Olympics. It takes physical strength and skill to wheel a sawn-off supermarket trolley while sitting in it, so I'll give them that one, that is a fair sport. What is not fair is that the competition is only open to those with no, stunted, withered, deformed or otherwise seriously defective legs. If they really are supreme athletes, let them prove it in open competition. They need have nothing to fear, after all most of the competitors have an advantage over the able bodied in that such legs as they may have are considerably lighter than those of someone who can walk. If they always win we will know the absence of pins gives an unfair advantage and we can introduce weight categories or handicapping with lead weights. If they do not win despite their apparent advantage, we will see that they are not top athletes after all.

As for the other sports, most are just an excuse for do-gooders to look on and say "didn't he do well, it's wonderful what he can do when he tries, bless his heart." To watch sufferers of Downs Syndrome racing on a track or in water is no different from gawking at the deformed in a Victorian side show, it is disgusting, patronising voyeurism.

Then we have blind runners. The more astute reader will identify the principal difficulty for a blind runner on an oval track, but the organisers of this absurdity are not stupid, they have thought of that. Blind runners go round strapped by the wrist to an able-bodied athlete charged with preventing collisions and keeping their competitor on the track. By definition this requires the able-bodied companion to be at least as fast a runner as his charge. In what sense is it an achievement worthy of an Olympic gold medal to run no faster than than someone you are attached to by a cord and substantially slower than most who were eliminated in the first heat of the same event in the real Olympics?

Most absurd of all is that it is called elite sport. These are, no doubt, the best limbless, sightless and mentally defective participants but that has nothing to do with elite sport. Elite sport is about absolute achievements, being the fastest on the day over 400 metres, throwing the javelin the furthest, riding a horse over high obstacles with fewest errors and so on. You can be a bit dim and still run fast, as is proved when most of our athletes give interviews, but it does not matter whether you are Einstein's lost identical twin or a complete retard, what matters is that in open competition you proved yourself to be the fastest or strongest. That is the measure. No if ands or buts, did you beat everyone else? If you are missing a leg you are not going to be the fastest or even in the top thousand fastest and, therefore, you are not an elite sportsman.

I enjoy playing golf but such is my limited skill that a score in the low nineties on a par seventy is an achievement for me. We don't see the PGA laying on special major tournaments for those missing the essential ingredients required to be a great player. What we do see is golf clubs all over the world welcoming me and my fellow hackers because we enjoy playing and are prepared to pay to do so. It is a recreational activity because we do not have what it takes to be the best. We also see sports clubs welcoming those with physical or mental handicaps for exactly the same reason. Lacking a limb or a large chunk of normal brainpower is no different from not having the physical coordination or the ability to concentrate required to be a top sportsman. By all means take part, enter competitions if you wish and enjoy it, but don't try to kid us into thinking it is real high-level sport. It is not. It is an excuse for the professionally sanctimonious to wallow in a pool of their own smugness and say how well they are treating the mongs and the cripples. A grotesque and patronising freak show.

Airlines and overreaction

So, another travel company has gone bust. No surprise there. They operate on tight margins and everything has been against them - rising dollar fuel prices and a collapsing pound, hotels booked in euros and paid for at the end of the season when the pound has lost 30% or so, lower than expected bookings because of the tumble into recession, no get-out clauses for block bookings of unfilled hotels, banks unwilling to extend credit, airports unwilling to extend credit for landing fees and a general tightening of private finance preventing the raising of cash from non-bank sources. MaxJet, Silverjet, Eos and Zoom couldn't take it and now a big package holiday concern, XL, has also gone to the great bucket shop in the sky.

What bemuses me is the extraordinary overreaction of newspaper, telly and radio coverage; anyone would think all the planes had crashed rather than stayed on the ground. Of course it is very unfortunate for those stranded overseas who might need to find a few hundred pounds each to get home but there is no reason why individual customers need suffer any great hardship. Everyone with half a brain takes out travel insurance giving cover against exactly such a risk, those who do not always seem to find a way to get home without having to sell granny into slavery. When they get home they often have the right to recover either the additional airfare they have had to incur or all or part of the price they originally paid.

As for those who have not flown yet the position is very simple, only those who paid the travel company directly in cash will have no remedy and I doubt there is anyone in that position. For both those on holiday who paid more to get home and those yet to travel there are various ways of minimising or eliminating the financial loss.

If they booked through an ABTA bonded travel agent they will get their money back. If they paid by credit card they can get their money back because they have a right to claim against their credit card company. If they booked using a debit card they can get their bank to recall the payment under a (little-advertised) interbank agreement. There might be some foolish enough to have paid cash to a non-ABTA travel agency but even they can usually claim the money back from the travel agent because in the vast majority of cases their contract is with the travel agent not the travel company.

In all but a very few instances the only thing lost is a week on the Costa Del Beercan. Unfortunate and disappointing though that is for them, it is hardly worth all the wailing and gnashing of teeth that goes on every time this sort of thing happens. I do wish the meeja would get a grip.

Thursday, 11 September 2008

Is "Gordon" criminal damage?

I always read comments about criminal trials through varifocal spectacles. Today's acquittal of a bunch of arrogant vandals charged with criminal damage for painting the Prime Minister's first name on a power station was no surprise. Had they engaged in criminal damage? The mere fact that they admitted daubing paint on private property would seem to prove the case. Is that enough to gain a conviction? Not by any stretch of the imagination. Why not, why is it that a jury can acquit those who freely admit the allegation made against them? The answer is partly legal and partly political.

The legal part is fairly simple and is this - the law is complicated and contradictory. We are all entitled to engage in peaceful protest if that is the course we choose to follow in putting forward our views. An act that might be criminal if done in another context can be rendered lawful if it is part of a peaceful protest. This might seem contradictory, but there is no difficulty in marrying the two legal concepts and there are many examples of it every year.

A demonstration might obstruct the highway, but there is a right to demonstrate (subject, sometimes, to obtaining permission). The offence of obstructing the highway can be outweighed by the right to demonstrate. If the demonstration becomes disorderly, the right to demonstrate can be outweighed by the need to keep the peace. A balance must be struck between the conflicting laws. That balance must first be struck by the police who have to deal with the matter on the ground and if it ends up in court it is then passed to the magistrates, judge or jury who hear the case.

Context is also important. A threatening letter sent to an individual might be construed as an assault, a letter in identical terms to an MP is likely to be viewed as part of the rough-and-tumble of political debate. It is, I suggest, right to draw a distinction between ten burly men marching on Joe Miggin's house and shouting "Death to Joe Miggins" and the same ten men marching to the Labour Party Conference and shouting "Death to Gordon Brown". One is a threat against an individual where there is no public interest in allowing the threat to be made, the other is a political demonstration.

The protest made by painting "Gordon" on a power plant involved both a clash of laws and an issue of context. It was for the jury to decide whether the law against slopping paint on someone else's property was outweighed by the right to demonstrate and it was for the jury to decide whether the context in which it was done was such that it should not be viewed as an unlawful act.

In addition there is a defence of "lawful excuse". This allows damage to be done if it prevents a greater threat from manifesting itself. It is a favourite defence of extremist nutters who perceive a fanciful risk of some catastrophe and vandalise the property of those they claim to be responsible for it. I do not know whether it was used in this case but it would not surprise me if it was.

I asked myself what I would have done had I been on the jury. Obviously I did not hear the evidence so my decision could be based only on what I have read and heard about the case. Part of me would want the Defendants to be sectioned under the Mental Health Acts for believing in the absurd theory of man-made global warming, part of me would want them imprisoned for the same dangerous idiocy. Part of me would want them acquitted because they did minimal damage while expressing views they probably hold deeply, part of me would want them convicted for going too far in making their point. Part of me would want them convicted because the act complained of added nothing to the debate, part of me would want them acquitted because it is not for me to judge whether it added anything to the debate.

And so we arrive at the political answer to the question I posed. Jury trials are not about applying the law strictly. Jury trials are part of our inefficient, deeply flawed and even more deeply ingrained system of democracy. Once every four or five years we can vote in a general election but that is not the only part we little people play in the governance of our country. We can vote also in local elections, we can lobby politicians, write articles on issues that interest us and engage in many forms of debate, all of which have the potential of affecting decisions made by those with power. We can also express our views if selected for jury service. There are very few cases each year which throw up matters of political interest but that was not always so.

Many years ago sheep rustling was a capital offence. The penalty was so out of proportion to the crime that juries regularly acquitted no matter how strong the prosecution's case. They exercised a political judgment, they decided that the law was unjust and rendered verdicts accordingly. Some argue that they had no right to do so but I disagree. The juror's oath is to "reach a true verdict according to the evidence". That phrase is not defined for the jurors, it is for them to construe it according to their consciences and judgment. If the jury thinks the law is unjust the true verdict might be "not guilty".

We will never know the reasons each individual juror had for voting for an acquittal in the case of painting Gordon. Perhaps one of them felt the right to demonstrate outweighed the property rights of the owners of the power station, maybe another thought the property in question was sufficiently public to justify its use for a political slogan, one might have considered man-made global warming to be such an important matter that any act done ostensibly in its prevention is justified, another might have felt it wrong for these protesters to be prosecuted when others who commit serious crimes are let off, yet another might have viewed the demonstrators as pathetic inadequates who deserve pity, and another again might have felt it best not to make martyrs of the haplessly selfish. There could have been a hundred or more reasons for the acquittals.

You can call it a perverse verdict if you wish. I am inclined to the view that it was an example of jurors doing what they do every day, returning what they considered to be "a true verdict". And let all commentators about the case realise one thing - the decision was not in the hands of experts with a special interest to promote, nor was it in the hands of politicians with an electorate to woo, nor was it in the hands of technocrats who look only at black-letter law, it was in the hands of a random dozen picked from the electoral roll. Only those twelve people had the right to decide the case. You might think they were wrong, but they were not wrong because they were the only people in the world with the right and duty to decide the case.

Monday, 1 September 2008

What is gesture politics?

Somewhere, in a house full of computer keyboards on which he types 24 hours a day, lives a man called Mr Anonymous. He leaves comments on blogs from Land's End to John O'Wherever. His comments produce reactions over the whole range, from "how did this person ever learn to type a word" to "I think I might end my blog now, he's too good for me." Yesterday I received a comment from Mr Anonymous which required me to think of the difference between gesture politics and power politics.

It is an interesting point. Like all interesting points it is a matter of how one approaches it. To an extent we are all like Humpty Dumpty when we choose to use a phrase without a clearly defined meaning, for Mr Dumpty words mean what he wants them to mean and when we use an ambiguous term or phrase we act in the same way. "Gesture politics" has no fixed meaning.

I opined yesterday on equality and inequality, and suggested that those engaged in the equality rights business by complaining about financial inequality and suggesting tax-based solutions were engaged in gesture politics. Mr Anonymous questioned whether they are in fact engaged in power politics rather than gesture politics. His question made me think of what I meant when I used the term "gesture politics".

To some extent we all have power. Parents have power over their children, teachers have power over their pupils, a landlord has power over his tenants, a team captain has power over the other players and the list goes on. These aspects of power are non-political because they are confined within a narrow scope and only involve the poweror(s) and the poweree(s) (I think I might have invented two new words, for which I apologise). No one is affected other than the powerors and thw powerees in the particular personal relationship. When parents exercise power over their children or teachers exercise power over their pupils no third parties are affected directly, no third party becomes obliged to do or desist from doing anything.

Political power is different, political power affects third parties who have no direct contact with those who exercise power over them. When I use the term "gesture politics" I mean acts of politicians which have no substantive benefit but which they believe will make the electorate view them more favourably; in other words, gestures which they hope will lead to future political power. The politicians in question might already have political power, but power today is only part of the equation because they also want power tomorrow. Today's policies might turn to dust but those who are convinced by their promises for tomorrow will vote for them anyway.

If you promote a policy which persuades people to be on your side you build up a reserve of goodwill. Whether in government or in opposition politicians need goodwill in the bank. They do not want to fight an election where every vote is up for grabs, they want a good chunk to be banked already so only the floating depositors need to be persuaded. Gesture politics is all about putting money in the bank.

There is an inevitable risk in trying to gain votes by empty gestures. Those who see empty gestures as empty gestures might be inclined to vote against those who promote them, that is likely to be no risk at all because those people would probably have voted against them anyway. Equally those who think the gesture to be a matter of huge substance are likely to be committed to the cause already. Gestures are not about making long-term converts of those on the other side of the political fence. They are about solidifying existing support by cementing the views of the converted and enticing some marginals into your camp. By definition a gesture has no substance, so those tipped into supporting one party because of a gesture cannot be expected to remain loyal through that gesture alone.

Gesture politics is not about doing anything substantive it is all about atmosphere, setting the tone, tilting the mood, changing attitudes. It is political musak. Of itself it might be nothing, but it adds to what has gone before and it adds to the background of what comes after. Is it about power? Of course it is, but not in a direct way. The real question with every act of gesture politics is whether it does substantive harm while enticing votes by pretending to do good.