TIME TO SELL EAST BUY WEST?

Asian stock markets finished January in a falling streak worst since last March. This is partly due to US rebound and rising dollar, but also fundamental disbelief in China's hard to believe economy that claims to be overtaking the size of Japan to become World #2 - is it an economy bubbling fit to burst? There is reason to believe China's economy is only half the size it claims, no bigger than say California or Italy?
The waning investor appetite since equities hit 15-month peaks 10 days ago is most obvious in Asia-Pacific stock markets. Jitters about the impact of monetary tightening in China that expose then burst its own fragilities never mind the fragile global economy is debated from New York to Tokyo and reflected in investment bank notes.
A report from Reuters shows mutual funds in China share those concerns.‘Risk Aversion Trade’ (RAT) that feasts off sovereign debt woes, e.g. Greece or Ireland; the approaching unwinding of stimuli (government exiting the banks) in the US, UK and EU; plus concern that financial assets remain badly priced, again overpriced, and growing if reluctant respect for good-old-fashioned economic analysis, encourage bubble-talk such as is Chinese property running of a cliff and maybe a year or two down the track is EU still heading for its real recession? China's fund managers appear to be cutting real estate stock weightings by a third.
The dollar’s days as the symbol of risk aversion are over. Yesterday it rallied to a 6-month high. The Anglo-Saxon economies are determined to deliver positive news e.g. UK out of recession and US fourth-quarter GDP rising faster-than-predicted 5.7 per cent, which in its wake will pull UK out of its morass. Volatility continues however as trader jockey to keep their jobs and focus on shorter-run profit plays.
Let's look at China's GDP - is it believable?
The economic success of China dominates its image in the world. Stats reports are perceived to be critically important, major (even dominant) factors in maintaining growth. But, official statistics about China’s economy do not make sense for many reasons. It is realistic to place more confidence in India’s official statistics. It is compelling to conclude that China’s statistics are political window-dressing – propaganda- driven to maintain an image that is deemed vital to its continued growth, but resulting in the economy being measured to be approximately twice its actual size.
When average wages are about $200 per month per person in labour force (800+ million labour force and probably really only 90% in work) while national income is $300 per month per capita (for whole 1300 million population)! The misalignment is not explained by trade surplus, net foreign investment inflow (inflow worth $50 per worker per month, $20 net) – but by over 40% of GDP explained as annual new infrastructure investment (fixed capital investment i.e. construction & machinery investment in a ratio of 1 to 4, without depreciation calculations) that is $150 per worker per month. Household spending is $180 per worker, or 35% ratio to GDP compared to 70% in developed economies. The likelihood is that assets growth values of fixed capital investment between project start and finish are being somehow included in GDP!
In 1985 to 2000 fixed capital investment was 30-36% ratio to GDP, half a high again as ever was in Japan (peaking in a construction and property bubble that burst in 1990) or Germany except in immediate post-war years. When the property bubble bursts in China its economy will deflate greatly and the banks all become technically busted as happened in the 90s! Chinese GDP components, which might look reasonable at first blush. But, subtracting investment, net exports, and government spending from GDP, we arrive at sum of consumption spending plus inventory investment, represented by a steeply falling curve than dived in ‘05, even if officially not shown until '07, and can't remotely be explained by inventories. The implausible behaviour is clearer when plotted as growth rates. In '05 for example citizens spent 17% less on daily necessities and luxuries than the previous year, but not what other official statistics say - that retail spending for the year was 14% higher than the previous year, alone double the remainder calculated for all personal consumer spending.
It is impossible to calculate China’s true GDP without independent access to growth statistics across the entire country. All regions report higher growth when that is most unlikely. In OECD countries growth is never evenly spread and they have policies to transfer income from rich to poor regions that China lacks. In OECD countries it takes 2 years of hindsight to make GDP figures accurate. In 2002, I recall the senior economist for HSBC writing: "We suspect that certain local officials may have seriously overstated fixed-asset investment in their areas to boost their political credibility. Analysts can still reach useful conclusions by focusing on trends rather than exact amounts in the official figures. Sometimes, however, the problem can exceed itself.”
Energy consumption and other physical indicators do not support the reported growth of national income and some countries dispute the trade data. Note: GNP is essentially wages + net profits + trade balance, also explained separately as consumption spending + savings + new investment. If the two sides do not add up as they should – is the balance achieved by inflating capital investment as a residual estimate? It is impossible to maintain Chinese wages at low levels to compete with India and other much poorer Asian economies and at the same time expect to become the world’s second largest national economy, to seek a status as globally wealthy when the people remain domestically poor?
Bank loans have grown by 15% and then last year 30% with a fiscal stimulus to force growth but when inflation has been reported for years as very low or negative, including currently negative, despite years of 20-35% money supply growth. In much of 2009, 2% consumer price deflation and 6% producer prices deflation – to push excess output into exports to a now unwilling importing world i.e. via massively subsidized exports. Bank lending (business debts and redit supported property asset values) must now be unserviceable by borrowers – unsustainable and heading for collapse, hence the recent decision to radically rein in lending by a third, which will not put the cat back in the bag, but trigger borrower defaults sooner than later! The State Statistical Bureau takes only 15 days to survey the economic progress of 1.3 billion people. Revisions are a farce: No growth figure was ever been revised down, and upward revisions are incomplete to the point of uselessness. At best, earlier activity is measured; at worst, results are manufactured to suit the propaganda. The aim is to be able to announce that the economy has overtaken the size of Japan’s economy (when in reality it is probably not yet bigger than France, Italy or California) or about 4-5 times the size of the USA trade deficit.
In mid-2009 the main engine for growth, again, was fixed investment, rising by one-third or twice the speed of retail sales, and equivalent to a staggering 65% ratio to GDP, an unprecedented figure for an economy that is supposed to have a significant market element and a figure that cannot be reconciled with a transition to the market. Either investment recedes or the market does.
For China’s economy to be producing $4.9 trillion and growing at 9%, China must be an economy worth 25 Hong Kongs and building equivalent of two new complete Hong Kongs every year. HK’s population is 0.5% of China’s but HK has 12 times higher average incomes – just under the level of Japan and USA. Japan’s exports are $5,500 per capita, HK’s $25,000 and China’s $1,000 (or 62% of all employment wages, which is a measure of how exposed the economy is to trade – worth 25% ratio to GDP!)
India’s data is more convincing. Exports are high at 14% ratio to GDP (proportionately twice that of USA, which has high imports at 10% ratio to GDP).
Beijing's response to the crisis is to intensify pre-crisis policies instead of recognizing that it must restructure the economy – change its business model – to deepen and broaden the economy internally and relay far less on trade and export-dependent capital investment and allow wages to rise, enforce 40 hour week and encourage domestic consumer spending, even to the extent of several years, perhaps 1-2 decades falling trade surplus turning into trade deficits, which its currency reserves can well afford. The damage caused by a global demand bubble inflated by overly loose American money has been talked up by the media as something to be healed by help of Chinese production and asset bubbles inflated by overly loose Chinese money. Brookings Institute in USA went further to look forward positively to the OECD world being dragged into higher growth by poor countries (Third World as was) falling into large trade deficits to be paid for by increases in ‘western’ aid.
But China appears to have decided to put off restructuring into some indefinite future when the external situation is better, whatever that means? Of course, at that ‘better’ time, the economy will appear yet again to be firing on all cylinders (except workers’ wages) and reform will--again--be dismissed/postponed. This is the same mentality that led the banks into the credit crunch.
Keeping one's eyes pinned to current GDP growth shows an improving Chinese economy. A realistic view shows a credit boom economy (but not for the mass of the citizenry) that is unsustainable, trying to drag itself and the rest of the world back along the trail that led to the current economic crisis and heading for a steep fall into a hole of its own digging.

BBC SPINS KING

(photo shows a BoE Beadle wearing the knew lightweight uniforms to replace the older heavy serge quality uniform - they, by the way, hate the new cheap style and want to return to the old uniforms, heavy and warm - BoE fashion advisor take note).
Bank of England Governor Mervyn King gave a speech at Essex University (his first since last October - a silence many assumed was because he was snowed in by complex calculations). The speech was 'meadia spun' by the BBC to suggest its focus was a severe criticism of government policy, and of No.10 more than No.11 Downing Street - an example of trying to eke a political story out of an economic one, a speech that was subtle, complex and a tour d'horizon of certain matters treated skillfully, subtly, perhaps too subtly for the broadcaster?
A clinically sober reading of the speech sees facts about the economic system's way of working described without implied political criticisms. Yet, BBC Radio 4 and BBC news web-site dramatically spun Mervyn King's speech(20 Jan) to read between the lines what was not there i.e. criticism of Government.
Full Speech: http://www.bankofengland.co.uk/publications/speeches/2010/speech419.pdf
The journalistic spin is summed up by "Mr King's remarks may have been aimed as much at number 10 Downing Street, as number 11" and in a pre-election climate there are those who would love to read the bank of England as favouring a change of government?
See last para. http://news.bbc.co.uk/1/hi/uk/8469373.stm
The journalist's implied view is that King was saying a higher savings rate is hindered by the government's deficit. But, to a trained economist, that makes no sense. Savings always rises and falls in exact proportion to GDP as government deficit rises and falls; they are national income accounting counterparts!
The quote "a key element in raising the national saving rate is the elimination over time of the structural deficit in the public finances". This states what is a factor, not what direction it is working in. UK savings rise as an exact counterpart of government deficit has been rising for many months in the same period as the budget deficit, and since Sept.08 to Nov. 09 (last published data), all UK sterling savings rose 10% and bank deposits by 50%. See http://www.bankofengland.co.uk/statistics/ms/2009/dec/bankstats_full.pdf Table B1.2
The quote, "But uncertainty about how and when fiscal policy will respond has a direct bearing on monetary policy. And markets can be unforgiving" is also cited loosely without direct comment or explanation, leaving it like a hanging chard as if implying political criticism. But as everyone should know uncertainty in monetary and to a lesser extent fiscal policy in their details are normal and necessary.
All that King wanted by saying this was to emphasise importance of statements adverting 'fiscal sustainability' - why, because he said markets gyrate around preliminary data yet to be much revised in hindsight, for which we can read spin to exploit unreliable data, and to say that new data in the next few months will be very much like that, but not to worry. He ends by saying what all empirical economists know that data remains unreliable for 2 years, which must have been his main point in the speech.
The first news about the speech on Radio4 was that King had said something like recovery would be hard and take maybe a decade - that seems later to have been dropped because it was not in the speech.
When King referred many times to 'saving' mainly about 'high-saving' countries he meant trade surplus countries and 'low saving' trade deficit countries. Most of the speech was about world trade imbalances - all of which the BBC ignored in favour of one reference to saving in UK, by which he mainly meant the need to reduce the UK trade deficit, and if there is an implicit message it is that in regard to 'national savings rate' and not household savings per se directly. Therefore if there is political criticism at all implied, it is to structure the fiscal impulse and to time the deficit reduction with respect to the economy's external account!
The key policy phrase in King's speech is actually, "Looking ahead, monetary and fiscal policy together must help to bring about a switch of demand from private and public consumption to net exports and business investment as the recovery takes hold."
There is a real credit crunch story here, which is that this is a repeat example of what the central Banks were saying, if too subtly, almost quarterly in recent years to all banks in credit boom economies, to very sensibly advise them to shift their lending away from mortgages, finance, and consumer loans, to industrial sectors whose borrowing from banks remained static or falling for a decade, as did Government's borrowing and debt, while mortgages, financial services and general private debt tripled causing the asset bubble. Banks ignored the message, not seeing in it an order to rebalance their loan books to care for economic sustainability. For your information, to take one example, lending to all small businesses in UK (half of private sector jobs) is only 5% ratio to GDP when all domestic economy lending by banks is roughly 40 times bigger!

Stiglitz's Six Lessons?

There have been times when white bearded Nobel prize-winning economist Joseph Stiglitz has taken on the mantle of Father Christmas in expressing a positive view such as over what should be done by World Bank for poor countries, and again now in respect of summing up where we have got to in learning from the Credit Crunch and the global recession it triggered.
In the China Daily, Joe Stiglitz summarised his view, “The best that can be said for 2009 is that it could have been worse, that we pulled back from the precipice on which we seemed to be perched in late 2008, and that 2010 will almost surely be better for most countries around the world. The world has also learned some valuable lessons, though at great cost both to current and future prosperity – costs that were unnecessarily high given that we should already have learned them.”
It would be a comfort to know that the world learns from mistakes - not so, in my view; the world so-called merely adapts to whatever the compelling circumstances of the time and place are and will otherwise repeat whatever is self-serving. Just as warnings of the crash ahead of time by the BIS, a few other central bankers and a handful of economists, and others here and there, these were discounted or lost in the noise in the trading rooms etc. Learning lessons requires playing politics and it remains a struggle to get the hard lessons accepted and then harder again to get these translated efficiently into succinct actions; there is no shortgae of resistence and red herring distractions, the 'blame game' is still being played.
"Better for most countries" is a debateable forecast given that there remains much unravelling, ever-yet widening ripples and aftershocks - businesses closing down and unemployment high or rising (except UK). Many countries, perhaps most, have gaping uncertainties about their external account and therefore of their growth prospects if any?
Brookings Institute recommended in a report late last year as a positive outcome that we could look forward to a massive trade deficit this year and next by emerging countries, sufficient to further narrow the trade deficit of the USA, and thereby replace it to help pull the rest of the world via export-led growth, what China, japan and Germany especially rely upon, however irresponsibly that is i.e. pull the rich world into better growth by improving its trade balances - a most unseemly paradox that the poor should by getting deeper into debt to help smoothe the prospects for the rich, who will then finance that via more aid to poor countries!
But, anyway, what are the six so-called “harsh” lessons, according to Stiglitz?
1. Markets are not self-correcting, and without adequate regulation, they are prone to excess. We could just as easily say markets are prone to unbalancing, to fashionable gyrations among different sectors. Regulation has yet to find a way to enforce stability; regulatory rules are more about accommodating losses and avoiding systemic risk, however forlorn that may be - and not about mintaining some securely safe balance in behaviour. Marjets are self-correcting, but not within the limits that would leave government out of the recovery equation.
2. There are many reasons for market failures. Too-big-to-fail financial institutions had perverse incentives: Privatized gains, socialized losses. This is pandering somewhat to popular anger. There are also massive privatised losses and there will be socialised profits from government support of the banks - stepping into replace private finance in funding banks' funding gaps. Self-correction is a matter of boundaries and timeframes, but self-correct they do, just not as painlessly as would be politically tolerable.
3. When information is imperfect, markets often do not work well – and information imperfections are central in finance. This is a non-sequitur; perfect information would also be disasterous. It would be more sensible to say markets work best when information is less than perfect but not so imperfect that they behave suicidally, or some equally asinine further insight into the bleeding obvious.
4. Keynesian policies do work. Countries, like Australia, that implemented large, well-designed stimulus programs early emerged from the crisis faster. The US, UK and others have implemented what can be classed as Keynesian if by that is merely meant higher deficit spending adjusted to whatever will propel economies back to a path of net new job creation. Emerging from the crisis, faster or slower cannot be fairly judged simply. The Eurozone, for example, had a sudden deep recession and then regained positive ground, but is likely to face its 'normal recession' in 2011 and 2012 if it follows normal lagged response to US recession. The UK recession may have just ended, but in world terms of US$ terms its economy has shrunk to a level going forward far below what is reflected merely in the economic cycle measured in domestic currency. China may look invilate but its official data is subject to shameless positive spinning and it cannot continue to rely on export led growth as before - it is not an energy exporter and has not yet learned how to rely on its domestic demand. Keynesianism that Stiglitz refers to is at local level - country-specific - when in our 'globalized world' we need to gauge Keynesianism in world economy terms and few are thinking in those terms beyond G20 meetings and UN or IMF research papers.
5. There is more to monetary policy than just fighting inflation. Excessive focus on inflation meant that some central banks ignored what was happening to their financial markets. The costs of mild inflation are miniscule compared to the costs imposed on economies when central banks allow asset bubbles to grow unchecked. Central banks actually worry about much more than inflation; they worry about the stability and integrity of their national or currency zone financial markets i.e. about banks, currency rates, external obligations and government bonds. It was hard for them to address the property bubble when there were many rationalisations justifying tolerance of fast rising property values, which let us not forget was a boon to emerging markets trade balances and debts as well as underpinning so much of bank debt and solvency in OECD countries. It is the residual high value of property assets and low mortgage defaults in Europe that are furnishing a floor or basis for banking recovery. Moreover, central banks and many others would accept that asset bubbles are an inevitable part of economic cycles that in turn are inevitable, even desirable. Therefore, the concern is about not letting asset bubbles become excessive like the famous Dutch tulip mania of John Law's Mississippi Scheme or Scotland's Darien Adventure and the many bubbles since then - but this would require giving central banks a power that many would call despotic and politically or democtraticaly intolerable? Stiglitz wants a Keynesian less Monetarist, less inflation-obsessed economic policy thinking - fine, but lessons will no be leatned or new thinking instituted without a new macro-economic theory and who is coming up with that - no-one that I can see getting that out to become the new othodoxy. Keynesianism is certainly helpful, but today we need a new Keynes - where is he, or she? A new theory however developed out of reconstituting past theory and lessons learned will also need a new central conception of economic growth, one less based on micro-economic analogy such as Adam Smith's pin factory and one based more on economic systems such as the economy of cities and far more global in scope. My advice is to look at economists such as Francis Cripps and Wynne Godley and their adherents, at UN models and at macro-economic policy models, which in future will need to have fully-interconnected macro-financial models. Even then, what happens if all we get is a cynical knowing perfect information outlook about the world's macro-economy. The Credit Crunch may have been disarming and impoverishing for those, many of whom who had much to lose, but has been a boon to others, not least a major transfer of wealth and income from rich to poor countries - suely a great thing?
6. Not all innovation leads to a more efficient and productive economy – let alone a better society. Private incentives matter, and if they are not properly aligned, the result can be excessive risk taking, excessively shortsighted behavior, and distorted innovation. Again, twas ever thus, and why should it ever be otherwise. I admire Stiglitz for having a go, but cannot see how his six points are lessons we have learned or should learn, and it disheartens me when great economists slip into journalistic statements that cannot stand rigorous examination. Would our economics graduates have come up with anything less and would they not have been sent back to the drawing board by any viv committee if these 6 points were the sum net total of their theses?
Stiglitz has elsewhere estimated the cost of the war in Iraq and Afghanistant to the US budget or economy as over a number of years costing about $3 trillions, which is on the same scale (or more) than the government finance gross investment-cost of Credit Crunch bailout and banking recovery (see Vanity Fair, April 2008). Given that Credit crunch and wars are coinciding surely we cannot learn economy lessons from the one and not the other, and from whatever other major singularities that can be pointed to and given a mult-$trillion price-tag or butcher's bill?

UK Finance, Basel blame-game, Climate failure

I have been teaching Basel II regulation to African bankers, in emerging market countries that had a good first half to the world credit crunch recession before also falling off the cliff. Returning via Uganda where an oil boom is about to disrupt a poor country with a half its 30m population is under 15, and the total is expected to triple in size by 2050, and via Dubai where the local upper echelon enjoys a socialism of free houses, guaranteed jobs and income, while the remaining 80% labour in construction, retail, and professional services without rights of abode (no family allowed in and expelled once unemployed), least of all citizenship -and much else, all of this amazingly to build a Manhatten dedicated to urban luxury in a coastal desert (200 futuristic skyscrapers) that briefly shook world markets because someone went on holiday and sought a 3-month maturity delay on $4bn of bonds - chump change payment for Abu Dhabi.
UAE has an economy the size of Scotland, which also enjoys socialist policies but applied to the other end of the economic food chain. Arriving back in Scotland, I find home snowed-up transport chaos, climate agreement failure in Copenhagen, and usual seasonal media summing up our world of the past decade and to year's-end.
Three ideas appear to stick out of the Christmas stocking. One, various theories to blame credit crunch illness on the cure, regulation. Two, as USA severely reduces its trade deficit, where will growth come from if not from emerging market countries dramatically increasing their trade deficits, the same countries that pleaded unfairness and acute sensitivety in growth prospects to Copenhagen climate change agreement? Three, dependency on Finance sector to reduce and we must rely less on asset gain versus actual net earned-income, while others argue that without finance sector red in tooth & claw and recovery in property prices what terms of trade advantage has the UK left to rely upon to recover lost ground other than very slowly? These issues in our globalized world are of course interconnected.
One emerging fashionable consensus is that in the financial crisis, banks’ equity was insufficient and quasi-equity could not absorb the losses. Basel Committee on Banking Supervision appears to agree and has proposed a comprehensive shake-up. From a banker's perspective, the impression is of a punitive regime, including increasing capital reserves by half, of which most is for liquidity reserves, and all of which must be of higher quality. Investors then hearing this sold bank shares round the world on fears that banks will have to continue to deleverage and raise oodles of fresh capital before they can restore share premiums, on top of taking off-balance sheet assets back on balance sheet, dilutive capital raisings on both sides of the Atlantic (to avoid the costs of government schemes), bonus caps and 'living wills'. The credit rating agencies, notwithstanding their own problems of mass-action compensation claims, are prowling like wolves round the winter campfires howling to downgrade any banks with living wills and any countries with rising deficits and debts. Also, matters are either so bad or so good that junk bonds look attractive and the dollar is rebounding as a safe haven, yet world economic growth continues looking liverish blotchy or blood-poison septicaemic!
It is a bit silly to focus on the idea that more reserves would have evaded the credit crunch problem. Bank writedowns and the lesser credit default losses have wiped out bank capital 100% and threatens to do so by another 100% before the crisis can have a final line drawn under it. What would have our economies and banks been like with 20-25% capital reserves ratio to asset exposures compared to 10%? For one thing losses would have been on a smaller scale anyway, but housing and office price bubbles and credit booms would have to have been severely curtailed with more bank lending to industry and far less to construction and property, but in a lower consumer spending environment with more savings diverted into longer term insurance and investment. The emerging markets poor countries would have been denied their boom of the past decade or so. We should not neglect what a boon that was to the world in shifting wealth and income from richest countries to poor countries. Now, it seems the idea (as set out by the Brookings Institute, for example) is that we should go back to a world economy driven by poor countries running rising deficits financed by aid. The FT says investors should welcome the Basel committee’s emphasis on beefing up banks' capital ratios so that "Funny money hybrids will be phased out". This is a blow to how hedge funds and private equity firms leverage their investors' capital via prime brokers and leveraged buy-ins etc. Banks will deleverage and should rebalance their lending away from finance (as they have been doing so enormously already that this triggered the credit crunch by denying banks' ability to roll-over funding gaps by borrowing from each other) and away from property towards industries that make tradable goods. The BCBS capital proposals are appropriately targeted: banks trading in derivatives, for example, will have to hold extra capital against counterparty risk. Furthermore, as the FT describes it, "a leverage ratio – the preferred measure in the US – will be introduced as a supplementary dial on the regulatory dashboard. While many European banks already report such a ratio, it will be harmonised internationally to cater for differing accounting treatments around the world". BCBS also wants to curb pro-cyclicality, requiring banks to bolster capital in good times. A minimum liquidity standard for internationally-active banks provides further protection, which will require a liquidity reserve equal to about one third more in capital reserves.
What is missing here is that governments stepped in to refresh banks' funding gaps (gap between loans and deposits previously filled by private sector intra-finance sector lending) equivalent to 100% of banks' capital reserves. Although governments have also widened their budget deficits to cope with falling tax revenues, the cause of much political hand-wringing, in fact this is more than covered by buying in government debt (nearly $2 trillions by UK and USA alone under Quantitative Easing financed by surplus margins between assets pledged by banks and government paper swapped in return). The profits that were previously private and are now public will in the recovery pay down at least half of governments' budget deficits. Governments (especially USA and UK) are showing that they can be and are being financial engines for growth. This is deeply unsettling for fundamentalists who believe in all government revenue and all growth only coming from private sector pockets and private sector's productivety efforts. The same fundamentalism lies behind emerging countries led by China sabotaging the Copenhagen Climate deal. They refuse to see green policies as just another business, and a growth business that they should be part of. The poorest countries see it as a reason for seeking more aid, more than the $100bn on offer by OECD countries led by UK & USA, while the richer emerging markets such as China especially merely see it as a cost like a green tax that will hold back economic growth and therefore China arm-wrestled 26 or so other poor countries to trade objection to Copenhagen for more investment and trade from China! This is 2-dimensional thinking. China ought to see green policies as another new business sector in which China should seek a large share. De-polluting and cutting global warming gases is no more a cost to industrial growth in general (regardless of whether climate warming science is right or wrong) than if 30 years ago the world had had resisted computerisation because it would add massively to business costs. Computerisation was, of course, sold as cost-saving. Computing became one of the biggest of all industry sectors. In hindsight we can see that the cost-saving argument was not true, but industrial groiwth did not thereby suffer. Instead a new industry formed. As experts will know, it is rare for new computer systems to generate cost savings before they have to be replaced again by a replacement technology.
The difference of environmental cost compared to computing is that climate warming counter-measures, emission-reduction targets and technology are not sold as cost-saving, only as 'saving the planet' when actually hey have more genuine chance of being a growth benefit in the long and medium term as was the case with computing. The argument can be extended to other industries such as health and education that were resisted by taxpayers and continue to be so resisted even if they have long since become self-financing parts of the whole economy. It is too easily presumed that moral reasons for doing anything must involve higher cost burdens while narrow business case reasons are assumed to be profitable efficiency gains. My own experience of over 30 years has taught me that such assumptions are generally wrong - that often the opposite is true.
Adam Smith's Invisible Hand should be understood by reversing the equation to recognise that by beginning with moral benefits economic benefits will usually follow. I don't doubt the same will be true of changing the culture in investment banking.

61.6 Billion, no shock, no horror, just secrets

Government is said to have loaned £61bn. No, it swapped c.£125bn assets of loanbook collateral, for £61.6bn of 3 month Treasury Bills probably. The deal was a Bank of England SLS type repo swap, not simply a loan as portrayed by the media and political comment. At no time was government or taxpayers money at risk because there was more than ample collateral. The value to the two banks was that they shored up their balance sheet balance by three times the treasury bill value i.e. c.£125bn came off balance sheet temporarily and c.£62bn liability came on, total £167bn, which may be approximately the funding gap that otherwise could not be filled. This redresses both banks end of year report of accounts. On capital reserves side, for example, Lloyds and HBoS announced in the same month (Oct.'08) £17bn capital raising of which £34bn would be government-owned preference shares, but ended up becoming much more. Their joint share value at the end of that month was only £18bn. RBS at same announced £20bn capital raising.
The Bank of England announced extending its SLS assets swap scheme for another 3 months. HBOS, I discovered had raised £45bn in securitisations, but without announcing the fact, keeping its identity secret in the regulatory news announcement to the Stock exchange. The Times discovered it had also received a secret £10bn loan from Lloyds TSB. It total therefore HBOS that quarter raised £80b in interbank wholesale liabilites and gotat least £100bn assets off balance sheet before year-end. It also had £35bn short-term liquidity drawing rights at the Bank of England for very temporary cash-flow smoothing.
It follows therefore that the interesting questions are:
1. why was this £61.6bn needed by RBS and HBOS? Answer: to fill the gap in 'funding gap' financing on liabilities side of the balance sheet. I surmise the banks were seeking to roll-over their maturing MTN programmes, but found their usual financing sources refusing to roll-over, many having been wiped out in the crisis themselves, and wanting their money back, that or at much higher rates e.g. LIBOR + 8%, a guess? The government (HMT & Bank of England) was simply providing paper (at a hefty fee) so RBS & HBOS continued to have balanced books. This was not I suggest about capital reserves or compensating the banks for credit risk losses and asset writedowns.
2. Bank of England say the RBS facility was repaid by 16 December 2008, and the HBOS facility by 16 January 2009 - how? Answer: simply the treasury bills run out, swap is reversed, banks take their assets back, not what people think 'repaying a loan' means.
3. Were the asset swaps rolled over or not? LBG and RBS announced in early '09 participation in Bank of England's APS, this time for c.£570bn assets in total as collateral, for which they might have received.
When treasury bills matured either the Bank of England could roll-over the swap and issue replacement treasury bills (and again without announcing the fact). There was revenue to pay from the assets to the Bank of England less interest on the treasury bills plus a fee, perhaps a total of £5bn? And HBOS it needed to find £25bn liability funding, and needed £3bn capital to take the assets back onto the books plus any other negative change in its liabilities to be funded. So, in HBOS case, instead of treasury bill roll-over, £15bn was converted into preference shares on 16th and became part of the newly merged LBG by 19th January (merger approved in Edinburgh Court of Session 12th January) and then LBG on behalf of HBOS had to only find £10bn, which neatly coincides with the figure claimed for both the cost and loss of buying HBOS.
In RBS case, it had to replace £36.6bn liabilities on 16 December. It also had a £28bn loss for the year. Government owned £11bn of RBS Ord. shares when bought at 49p, and it bought £5bn Pref shares. Note that by 19th january RBS shares had fallen to their lowest at 10p, re to 60p end of August and are today only 35p. On 8th January, RBS announced participation in the new Bank of England APS to replace SLS for £325bn (reducing RWA by £144bn and saving capital reserves about £13bn). This swap may have been executed or held in some holding form in exchange for Bank of England unencashable cheques until EU Commission approval - we don't know how precisely these assets are currently matched to liabilities? This is a murky area of enquiry.
Meanwhile the private financing of funding gaps is recovering with renewed appetite for Covered Bonds (like Germany's Pfandbriefe) backed by mortgages in place of RMBS e.g. LBG's £4bn CB issue sold in September. This confidence is why it seems ok to the bank of England and Government to provide more details now about the full extent of their support for UK banks.
I wrote the following to the FT letters: Sir, disclosure by Bank of England to Treasury Select Committee of £61.6bn loaned or swapped for assets wth RBS and HBOS (FT, Bank of England bailed out RBS and HBOS, 24 Nov.) should be no surprise since the sums involved were within the banks' respective liquidity window drawings rights with the Bank of England at the time, and fit with information I provided to Edinburgh Court of Session to approve the takeover of HBOS by Lloyds TSB. I stated then that asset securitisation sales of over £40 billions by HBOS without public announcement and questioned whether important information was witheld that was arguably critical to informing HBOS shareholders' before the takeover vote? Important information was witheld. Details and argument about the issues were entered into the court record. How much shareholders must be told about Liquidity problems and funding gap financing, a central problem of the credit crunch, is not sufficiently clear in FSA regulation and The Companies Act. Bank of England assets swaps with the banks under the liquidity window, SLS or APS schemes may be kept secret. This is allowed by the 2009 Banking Act. "...Treasury shall as soon as is reasonably practicable lay a report before Parliament specifying the amount paid (but not the identity of the institution to or in respect of which it is paid). If the Treasury think it necessary on public interest grounds, they may delay or dispense with a report under subsection (6)." Parliament discussed this. There were objections, but the Act passed. Liquidity assistance to the banks was expected to be reported in October. Therefore, there should be no political surprise when it is reported in November.

BANK LOSSES TO DATE

Top U.S. and European banks have lost over $1 trillion on toxic assets and from bad loans since the start of 2007. Losses from 2007-10 are expected to top $2.8 trillion, with roughly two-thirds from loans and the remainder on securities, according to International Monetary Fund forecasts. U.S. banks are expected to take a $1 trillion hit and European bank losses will reach $1.6 trillion, the IMF said last week. It said U.S. banks were about 60 percent through their needed writedowns, while British and eurozone banks had recognised only 40 percent of losses.Below is a list of estimated losses (in billions of dollars at current exchange rates):
(apology for formatting here)
BANK_______________2007_2008_2009YTD___TOTAL BILLIONS
Citigroup____________29.1_63.4_21.8_______$114.3
Wachovia Corp*_______4.0_73.4____________$77.4
Merrill Lynch**_______25.1_38.6____________$63.7
HSBC_______________19.3_30.3_13.9________$63.5
Bank of America______12.1_29.2_17.2________$58.5
Lloyds&______________6.8_28.9_22.3________$58.0
UBS_________________50.6__3.1____________$53.7
Royal Bk Scotland_____7.0_23.5_19.6_______$50.1
Fannie Mae__________4.7_26.9_15.4________$47.0
Freddie Mac_________5.2_24.4_12.8________$42.4
Washington Mutual***5.1_36.7_____________$41.8
Barclays____________7.0_16.5_13.1________$38.0
Lehman Brothers****12.5_14.0_____________$26.5
JPMorgan Chase______4.5_10.2_10.4________$25.1
Commerzbank/Dresdner3.9_13.3__4.5________$22.3
Morgan Stanley_____10.3_10.1__1.7________$22.1
Wells Fargo_________3.5__8.7__8.2________$20.4
Santander___________4.8__8.3__6.6________$19.7
Deutsche Bank_______4.0_11.2__3.6________$18.8
Credit Suisse_______3.5_11.9__1.5________$16.9
IKB &&___________________________________$14.7
National City*****_______________________$14.0
BNP Paribas+________2.4__8.0__2.5________$12.9
Unicredit___________3.5__5.1__2.4________$11.0
Fortis______________3.1__7.6_____________$10.7
C.Agricole+_________2.7__4.4__3.1________$10.2
ING_________________7.1__2.4_____________$ 9.5
Bayern LB___________1.1__8.0_____________$ 9.1
Intesa Sanpaolo_____1.6__4.5__2.6________$ 8.7
Societe Gen+________1.3__3.7__3.4________$ 8.5
Goldman Sachs_______1.7__4.9__1.9________$ 8.5
BBVA________________2.7__4.2__1.3________$ 8.1
Natixis+____________2.0__2.5__3.1________$ 7.6
Canadian Imp Bk Commerce_________________$ 6.5
Erste Bank__________0.8__2.5__1.3________$ 4.6
Standard Chartered__0.8__1.8__1.1________$ 3.7
Bear Stearns******__3.0__0.6_____________$ 3.6
WestLB___________________________________$ 3.0
Rabobank____________0.8__1.7_____________$ 2.5
=============================================
To be updated___________________Total $1,047.6(Sources: Reuters/annual reports/company filings) Estimates based on writedowns and losses from subprime securities, mortgages, CDOs, derivatives and SIVs, and losses on bad loans, or non-performing loans. The definition of a bad loan is complex and can vary between countries and often includes a provision for future loan losses.
NOTES:
ACQUIRED BY WELLS FARGO AT THE END OF LAST YEAR.
* ACQUIRED BY BANK OF AMERICA ON JAN 1.
** ASSETS ACQUIRED BY JPMORGAN IN SEPTEMBER.
*** FILED FOR BANKRUPTCY IN SEPTEMBER.
**** BOUGHT BY PNC FINANCIAL SERVICES GROUP IN DECEMBER.
***** BOUGHT BY JPMORGAN IN MARCH 2008.
& Includes HBOS, taken over by Lloyds in January.
&& Bought by Lone Star in August after state-led

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