JOHN CLARK's Blog

Iceland today, who tomorrow?
Calling the bottom of the market will get progressively easier as the weeks pass. If the UK stock-market keeps losing a 100 points a day, by Christmas, it will be worth nothing at all. The imponderable is precisely what level the market will bottom and how long it will then take to climb out of the mire.

There are some ugly problems already facing us and more are likely to emerge. Can Iceland, with less than 300,000 people continue to behave like a sovereign nation state with relation to its banks - I doubt it. So, if no-one will lend their banks the money to continue independently, the options are either a firesale, or a take-over of its commercial banks by some notional 'overseas' interests, (would the Norwegians want to buy? Is there a sovereign fund waiting in the wings? I doubt if Merryl Lynch or Lloyds-HBOS, or Deutsche Bank would really be keen to take them over, but who knows?) Much the same might be said for Ireland with rather more people and rather bigger institutions.

To follow the example, ask yourself whether the Scottish National Party are pressing to leave the UK and to take over a role as lender of last resort for its various financial institutions with a shiney new currency managed from Edinburgh.

Nations may not be able to go bankrupt, but their banks certainly can and it may not be possible to prevent this.

The notion of the nation state as lender of last resort is based on the assumption that the national economy is bigger than the financial institutions. In a globalised economy, this is no longer the case.

Iceland's problem is an interesting microcosm of the general problem. It would be fairly easy to keep catching fish and supply the island on a barter basis, or abandon the local currency and use say Norwegian krone. People would lose their savings, but this is something that has happened many times around the world in the last 100 years, (think of Germany with its half dozen currencies since 1900). As Iceland has a well developed infrastructure, after some years austerity, the local economy would pick up.  The corporate issues might then be solved on a case by case basis and much of the pain would be felt outside Iceland. Iceland would then have to rebuild some local financial institutions based on their new circumstances, probably with a new currency.

Without a concerted co-ordinated programme, government intervention in the markets will become increasingly ineffective, as reactions from one national government cancel out the advantages gained by previous gestures country by country, the tediously predictable domino effect.
Every European country, including the UK, that gets embroiled in this turmoil is much more like Iceland than it is like the USA.
The EU in particular seems very poorly placed to do the co-ordinating, ironic since economic stability was one of the core functions anticipated by the creation first, of the  European Coal and Steel Community after WW2, then its successor the EEC 'Common Market' in the 1950's and in due course the EU today. Germany and France do not want, or are not able, to bail out fellow members and there are rather a lot of members nowadays.

The press are beginning tp suggest that many Banks in he USA will not participate in the Paulson Plan and will try to 'brave it out' on their own.

Not news to inspire confidence.

If the European Banks follow that strategy, Governments might be well advised to create new institutions to address the problems of individual businesses and let the existing banks carry on within the existing rules tp sink or swim. If that is a serious option, and why not, then governments should start preparing the groundwork now and let the commercial banks go their own way, rather than muddling through the crisis with half-baked ineffective measures.

We all need banks. Governments need banks. Businesses needs banks. Industries need banks. Individuals need banks.

But do we need the Banks we have?

The most curious aspect of the current economic crisis is that the gradual development of the recession has been clear for at least a year, yet the financial institutions failed to finesse the problems, until eventually, they themselves have been dragged into the quagmire and needed massive interventions from governments and central banks internationally to keep the raft afloat. The Paulson Bailout Plan, which passed the Senate yesterday has been diluted from its initial purpose of saving the US Banks to include initiatives that signal some kind of recognition of the breadth of the recession. So what happens next, assuming the House of Representatives pass the Bill this week?

In the US, Paulson and Co are going to be creating a new institution and committees, that will look less like a public sector Goldman Sachs that I suspect Paulson's instincts were leading him to and more like a traditional government department, alongside all the existing bodies that deal with regulatory and budget issues. ( (3) ESTABLISHMENT OF TREASURY OFFICE.— (A) IN GENERAL.—The Secretary shall implement any program under paragraph (1) through an Office of Financial Stability, established for such purpose within the Office of Domestic Finance of the Department of the Treasury, which office shall be headed by an Assistant Secretary of the Treasury, appointed by the President, by and with the advice and consent of the Senate, except that an interim Assistant Secretary may serve pending confirmation by the Senate.) The Paulson 'TARP' will no doubt be staffed and run by bright people, but whether they will have the leverage to get the intended job done remains to be seen. The funds at their disposal are not a 'scale larger' than the kinds of resources being thrown into the maelstrom internationally.

Certainly, out in the everyday world of small and medium sized business, organisations and industry, everyone who runs a budget is going to be asking a different version of the same question, 'can we do what we have intended to do, tomorrow, next week, next month, next year...?' When prudence gives way to caution, the responsible deployment of resources is replaced by a tendency to hold back as 'confidence' collapses. Uncertainty about future income matches doubts about the ability of suppliers to continue providing goods and services on reasonabole terms, whether it is a classic withdrawal of local authority services, like swimming pools, because of economies by other local authority departments, schools cutting class visits to those pools, or a much wider issue like the collapse in new car sales reported this year and the end of the house price bubble. 

Recessions are tedious. Initiatives which are deferred, often fail to re-emerge. New ventures that fail to receive funding find their industry has moved on by the time the finance they need becomes available. Children grow up in an atmosphere of diminishing expectations. Cities and regions can fall into decay that may need decades to recover.

We have yet to see reports from pension funds and essential services like health care and their response to the changes brought on by recession. Nor have we seen the effects that an economic in recession has on local authorities and public services. All this will begin to seep through in the next couple of years.

There are three enormous mirrors in modern economies, one in which borrowing and lending are reflected between banks and their customers, the second between the public sector, including defense, who are the key customers for millions of private businesses and thirdly between the state and the taxpayer.

When these mirrors crack, the contrast between cash and finance suddenly becomes clear. Cash has a simple function to enable purchases, but finance is not only the provision of cash, but a licence for people to proceed. As people are refused permission to carry out their projects and programmes, the real impact of recession will become clear - a licence to print money is much less important than a licence to spend it.

The first attempt to pass the Paulson Package failed and was met with a sharp sell-off, then a rebound in the markets the following day. Another attempt is to be made to pass an increasingly dissipated package of proposals. Most commentators agree the basic issue is the undercapitalisation of the banks and their reluctance to lend to one another on the money markets. The level of undercapitalisation is amplified by credit ratings being lowered on their assets

The international dimension of the current
crisis is being underplayed.

Having funded US Debt, having fed the North
American and European markets with cheap goods, the developing/emerging
economies, China, India, Brazil have been conspicuously absent from attempts to
deal with the current crisis.

What are they concerned about, a collapse in the
value of the dollar, which may be among the next stages of this crisis. Perhaps,
from their point of view, the health of the US economy is less important to them
than it might have been twenty five years ago? Is the United States decoupling itself?

The notion of 'trickle down' has predominated in US politics since the Reagan years, but the reality for most people is that large chunks of their income are 'syphoned-up' month by month, with the only variable in their net income being the amount of cash left over to pay for everyday outgoings like food and entertainment.

A package that addressed the syphoning up process would soon see the money in the hands of the financial institutions at local, national and subsequently international level. If a large part of this crisis is the risk of default by small borrowers and the effect this has on the credit rating of the banks who have done the lending, might a package that addresses the risk of individual borrowers and consumers being thrown into misery be more appropriate than supporting the organisations who have done the lending? The ratings on some of those toxic assets might then be improved and after a period of (well deserved) pain the bank's need for new capital redrawn within more normal parameters.

Monday morning in Europe isn't the best time to comment on the day's events, as more is bound happen once the US Markets open later in the day. However, this morning saw the publication of the draft proposals for the Paulson bailout, which may, or probably may not, immediately charm the markets, as they have to be pushed through Congress in the days to come. So a degree of uncertainty remains, about the agreement and more importantly its effectiveness. The first thing that struck me about the proposals is that the funding will be made available over a period of time, rather than the swift intervention many had anticipated; the second thing, that it covers a wider range of potential beneficiaries than Wall Street, including towns and cities, so there will be some leeway for an incoming administration to decide how the deal is implemented once Paulson is off the scene following the US Elections. The Paulson package will only represent a six or seven percent increase in US Public Debt at worst, so the numbers are perhaps less dramatic than the notion of $700bn appears to someone like myself, who is more familiar with industry.

Before that happens, however, we are likely to see truly horrible set of quarterly numbers from corporations around the world and all sorts of organisations who would like to borrow money for good reasons, probably won't be able to get their funding. The period between now and December will be extremely interesting as everyone tries to position themselves before their end of year figures are cobbled together.

One of the nastier aspect of 'end of year' calculations is for profitable organisations to look at their tax obligations and match those against assets, whose value has fallen. There is a point at which dumping shares for a fraction of their current market value can save more on the tax bill than the loss incurred by selling. Tomorrow is September 30, the end of the quarter, one of the stickier days in the calendar, while the first or second week in December will see many organisations hoping to have completed their significant transactions for the year.

The next ten weeks look like being memorable, sadly, as the autumn when the 'weak were driven to the wall' and some other surprising victims followed them.

The biggest surprise for me, however, has been political. Here in Europe, at least, the left has barely uttered a whimper, far less provided a convincing critique of this very nasty economic crisis.  

While it seems John McCain has boarding his aircraft en route for the first

Presidential debate, if as he had threatened, he had not taken part, then surely

Sarah Palin should have taken his place, just as she would were he to be incapacitated

following an election victory?

The factor that I cannot make much sense of re the Paulson plan is the effect of the forthcoming
elections, not just for President, but also for the US Congress, which in a few weeks time will create
a completely different political landscape in Washington.
For the Paulson Plan to be convincing, like a sheep dog snapping at the heels of the herd, it should
be reasonably swift in planning and immediate in execution.
Tonight, there is the news that McCain (who I don't particularly respect) has pulled of debates with
Obama (who I know very little about).
I just asked myself what both camps might be saying and, in a truncated form, it comes out something like this:
McCain: to Republican Party leaders -
Q1: What the hell am I supposed to say in the next few weeks?
Q2: I do not want to be hamstrung by a financially crippled state.
Q3: If elected can we bring the inauguration forward, so that my team, not Bush' people are in charge
from day 1 - the transition is always a messy phase when next to
nothing can get done.
Q4: Do you really want me to continue as your candidate, because if you do, I need to be inside the
decision making process, not out on the campaign trail.
Q5: You have probably wrecked my campaign completely,ensuring that many republican senators
and members of the house will loose their seats - shall we go home now?

Obama: to Democratic Bosses -
Q1: If we are railroaded into accepted the Paulson Plan, don't expect to be able to pursue any of the policy initiatives we have been campaigning on - are you really going to support this?
Q2: It looks as if there will be a democrat majority, so are you going to vote like turkeys for Christmas by supporting the
Paulson Plan, or will we be blamed for wrecking it?
Q3: Are you working on a credible alternative to the Paulson proposals - if so, lets put them on the table as soon as possible.
Q4: Should we just let the Republican Administration dig its own grave and wait to pick up the
pieces?
Q5: I have a terrible feeling I am going to be elected as the most powerless president since Jefferson Davis led the south and
something has to be worked out now, or it will be too late to avoid calamity.

Both sides have campaigned on the basis of opposing entrenched interests, yet look likely to have to bail out the very organisations they have been talking about.

November is a cruel month, at least for US politicians every four years.

How can other international political leaders handle this uncertainty? Angela Merkel made a dismissive speech about the US/UK position on finance, quietly burying the notion of German participation in a rescue initiative. She does have a point, since the German banks spent a lot of money buying seemingly worthless products and have already taken enormous hits.

I remain genuinely puzzled about the situation that will arise in a few weeks time.

Paulson Money for the People.

The political debate over the Paulson rescue plan has begun, but not many voices seem to be being heard.
What would you do with $700billion dollars? The Paulson plan seems to address the institutions, who have been the public face of the
current crisis, but what about the people? Nothing I have heard addresses the basic problem of 'negative equity' and the crisis
facing people defaulting on their mortgages. Why shouldn't the money be directed towards them in the first instance? Of course, people who
have never missed a payment on their debts will say this is unfair, so why not include them too. How could this be done?

One option might be to create a 'Paulson Bond' in the name of every man woman and child in the USA.
It might be worth around two thousand dollars each, or say $8,000 for a family of four. Unlike the cheques that were mailed out last year,
(and promptly forgotten), to help offset the rise in oil prices, the 'Paulson Bond' should be none negotiable, except for a highly restricted set of uses, for
example.

   1.Making repayments against the
      principal owing on mortgages.

   2.Paying income tax

   3.Locking the money into a pension fund.

   4.Paying funeral costs for the elderly.

In each of these options, there would be a significant trickle up, both to the treasury and the financial
institutions, while alleviating individual financial problems.

The first option, repaying mortgage principal would help families, enable the rescheduling of their debts
and increase the quality of all the asset backed products which have been at the root of the current financial crisis. It wouldn't let the
banks off scot-free, but there is no reason to suppose that theyshould be allowed to get away with a complete rescue. For a typical
family, the repayment would both reduce their mortgage interest payments and reduce the timescale over which their mortgages are
repaid. That would be a double benefit, reaching long into the future. It might also reduce the need for families to sell off shares at a time when market prices for equities look like tanking.

The second option, paying income tax, would simply reduce the cost of the project to the government, but also remove some of the stress families are feeling in the short
term. $8,000 off your tax bill pays for a lot of children's dinners, shoes and clothing, or a mortgage payment or two.

Locking the money into a pension fund might only make sense for the prosperous middle classes, but for a baby who will reach retirement in the year 2073, the accumulated value of a pension fund created with $2000 now, might help keep the wolf from the door, whatever happens to the dollar in the mean time.
This third option should not exclude the possibility of topping up the pension scheme as time goes by.....

The fourth option, paying funeral costs, might seem macabre, but for many old people the notion of paying for their own funeral is a matter of pride. The first three
options will probably make little sense to the elderly, but this fourth option might make a lot of people more cheerful as they come towards the end of their lives.

Spreading the Paulson largesse across the American people doesn't seem to have been an option anyone has considered, but in each of these cases, the financial sector will gain some benefits and I don't think anyone believes that they shouldn't have to share some of the pain.

The notion of a US 'Bad Bank' mopping up the debris of the 'credit crunch' to the value of $700billion is rather a tantalising prospect. Much depends on the value they put on the diminishing assets they will be offered by the market. Will it be 40,50, or 60% of their notional value, or some kind of sliding scale based on the degree of toxicity.

It raises an interesting challenge to the spirit of capitalism and entrepreneurship, since it presumes there are no potential immediate commercial buyers. If the valuations are perceived to be too low, then the sellers will have a strong incentive to go out and find other buyers and I would be astonished if they cannot find them.

The 'Bad Bank' would therefore be creating a benchmark. The sellers would find themselves open to criticism if they turned away anyone offering a percentage point or two above that. If the assets are really so worthless that the perceived value of 40/50/60% is meaningless then the 'Bad Bank' should probably offer less.

Given there are a number of qualified bankers looking for new jobs, an entreprenuer has about a month to put a team together, bring in the necessary resources and get moving. No doubt they would want to cherry pick, but with sufficient energy, a new market ought quickly to emerge and the 'Bad Bank' need be little more than an auctioneer, which shouldn't cost $700billion.

On the other hand, if the rules are too loosely defined, the 'Bad Bank' will simply become a repository for the finance industry's failures and its extended existence would confirm the suspicion that Wall Street and the City of London are a charade to be dispensed with.

Since any new money is likely to come from overseas, say the fabled sovereign funds, or investors from the Mid-East, China, or India, Brazil, or Japan and Taiwan, the prospects for the UK Pound and the US Dollar must look pretty dismal.

Rather than following the US model of building a bank to soak up the failures of other banks, perhaps the UK should take a completely different approach, let the failures flounder, and create an institution to deal with housing finance and manage new consumer debt directly, matching it with an insurer. That wouldn't be to hard to set up either and might make a profit.

By-passing the failed sector to leave the commercial banks to wallow in
the consequences of their own decisions would be an interest challenge,
but would surely concentrate the minds of fund managers to come up with something innovative and create yet more opportunities for forward looking entrepreneurial success!

 

The sight of powerlines and small transformers draped on poles across US towns and suburbs astonishes European visitors to the USA, since urban power distribution in Western European cities is done with buried cables.

As several million homes have been without power in the wake of Hurricane Ike, it might be worth asking whether the time has come to dig up the streets and introduce a modern weatherproof approach to electricity supply. In the wake of the financial crash, which has ruled out housebuilding as a way of regenerating the feeble US economy, this might also be a way of keeping thousands of construction industry workers in a job and improve the country's energy efficiency.

 

 

Investment bank Lehman Brothers seems to be on the way to losing a lot of money as it proceeds through Chapter 11 bankruptcy. Some people seem to think this will top the $100billion mark, though this may prove to be higher, or lower now the music has stopped and the company's business is unravelled.("Over EUR150 billion ($220 billion) outstanding of Lehman bonds are owned by somebody, so the market is going to lose EUR93 billion," said analysts at Societe Generale Monday, assuming a recovery rate of 40%.Several other market participants have indicated that this is a sensible benchmark. ---By Michael Wilson, Dow Jones Newswires; 44 20 7842 9349, michael.wilson@dowjones.com)

There is a tendency to focus on stock market turmoil in financial crisis', but every dollar that's going to prove to have disappeared will represent a hole in the pocket of some-one somewhere.

Alongside the list of creditors with unsecured loans, (published as part of the Chapter 11 procedure), the most obvious losers will be governments, who will see their tax yields reduced as the losses are absorbed into corporate balance sheets. As the process of downgrading assets move apace, more and more financial businesses, including the insurance and pensions industries are going to come under pressure. No-one in the media have dared, so far, to speculate about the progressive impact on independent and sovereign funds as the entangled market for CDS's are unravelled.  Slowly, but surely, sector after sector are going to feel the squeeze. Perhaps, Russia has more to lose than other countries, as the oil price retreats and the Moscow Stock market loses value. Interesting to see whether this brings a new sense of commercial responsibility to the business situiation there.

Even the sackings and freed up office space as businesses contract will have an impact on property marekts and office rents in cities like London and New York.

The greatest horror scenario, however, is left for countries with relatively few institutions to fail. Germany has recently seen the amalgamation of Dresdner Bank with Commerzbank, while Deutsche Bank have taken a major stake in Postbank.  In the UK, the agglomoration of building societies and banks means there are fewer entities to fail, in a pattern of take-overs that has begun to cross borders in Europe. A handful of failures of the scale of Lehman Brothers could effectively remove banking services from whole regions. Commercial banks have no obligation to provide the kinds of services that people need on a day to day basis, whether it is simple transactions, savings, private pension arrangements, housing finance, overdrafts and loans, credit cards, or insurance of many different kinds, from cars to homes and businesses. 

It might be a good time for businesses, individuals and even local authorities to come together and explore the potential of small scale financial services companies, as local banks. Could they prosper? Almost certainly if local spending, local authority salaries and services were channeled through them. Almost certainly, if European funds for projects in their region were paid via their accounts. There will certainly be no shortage of well-qualified labour looking for work and a proportion of the former City banking community might be content to settle for the predictable, if tedious, life of a small town bank manager, dealing in pensions and mortgages, loans for small businesses and personal finance, rather than their derivatives. They might even have some skills and experience to bring to the job, assuming they can over-come greed. Is that the silver lining?

My novel, 'The Swoop' was written assuming the Great British Crash would happen about now.

Go here to download it: http://www.berlinpicturecompany.com/ebooks/ebooks.html