How Syriza crashed Greece.

Consider a single-currency area, like the UK. There are bits of it that are doing well. London and the South-East for example, that subsidises the rest from its excess taxation over expenditure. Only London and the South Eastern regions are net contributors to the UK treasury, but it is barely questioned there that it is reasonable for taxes levied in Reading be used to build roads in the Rhonda or Rothesay. Thus the Welsh for example are compensated for having an interest rate not quite suitable for their economy, as interest rates are set for the economic centre of Gravity, which in the UK probably lies somewhere around Oxford.

Now consider the Eurozone. There are no fiscal transfers, because Germans, who didn’t mind subsidising other Germans upon unification, baulk at subsidising Greeks whom they regard as feckless layabouts (erroneously – further discussion here). But the centre of Gravity of the Eurozone probably lies somewhere around Frankfurt. Thus the Germans, and their associated northern European countries have an appropriate interest rate, and the Spaniards and Italians do not. The Spanish Government, denied monetary levers in the run-up to the crisis, sought to cool an over-heating economy by running a fiscal surplus. You cannot accuse the Spanish Government of being “profligate”. The same is true of Ireland. Portugal’s situation wasn’t quite as clear-cut, but their debts were not out of control. 
Obviously, the asset price bubbles built up in Spain and Ireland, and the subsequent bust took out their banks, which required bail outs. Denied the stimulus of looser monetary policy, by an excessively hawkish European Central Bank, who’s setting rates effectively for Germany, the only other option to these economies is a devaluation in place – cutting wages and living standards until they’re competitive with Germans.
The falling tax revenues mean deficits. Lack of EU fiscal transfers mean Austerity, and meanwhile the ECB is still not responding with interest rates. For the periphery, even Governments like those of Spain or Ireland who sought so, so hard to be prudent in the good times, the Euro is massively pro-cyclical. There will be booms, there will be massive busts and there’s little, if anything any Government in Madrid or Dublin can do about it. This was predicted by economists from the notorious pinko Paul Krugman to arch-“neoliberal” Milton Friedman.
Added to this, the Greeks were not prudent. They near-openly lied about their debts and deficit to get into the Euro, hoping lashing themselves to the mast would encourage some degree of fiscal sanity. But the problems were too entrenched, and sorting them out meant unpicking the settlement of a civil war. The result is that while the Spanish and Irish have endured a savage recession, the Greeks “devaluation in place” was a depression costing 25% of GDP. A grinding, seemingly endless round of austerity and reform that left 50% youth unemployment and an economy in tatters.
The ironic thing about the election of Syriza in January 2015 is that Greece had done the hard work and by mid 2014 was the fastest growing economy in the Eurozone, and had a primary surplus (meaning they were balancing the books before debt service was considered). Given the bailout terms, Greece’s debt service took a smaller proportion of GDP than did Ireland, Spain, Italy or Portugal. By 2014, Debt to GDP in Greece was actually falling. All they needed to do was keep up the reform, and “Austerity” – continual tax rises and spending cuts would no-longer be necessary. The Germans would get their money back, eventually. Greek growth would take over the heavy lifting from austerity after years of tax rises and spending cuts. Economies emerging from such depressions can often grow fast.
Then, in January 2015, they elected a bunch of hard-left Yahoos, who encouraged a bank-run, shattered what was left of business confidence, and were forced to introduce capital controls because of a childish and unreasonable petulance wrought by economic fantasy which could only have come from a Marxist academic “economist“.  Privatise state assets? The horror! Make civil servants turn up to work, and don’t let them retire on 80% of salary at 58? The inhumanity! The Greek people may have been sick of Austerity. But if they’d just seen it through, they’d be heading up now, rather than enduing a 3 week bank-“holiday” and queueing up at ATMs for their daily ration of cash. Syriza have probably cost Greeks another, entirely unnecessary, 10% of GDP, and the resultant continuation of Austerity that comes with it. This makes Yanis Varoufakis (the “minister of Awesome” according to twats on Twitter) the most unsuccessful finance minister in history.

All the pointless yes/no referendum on the terms of the bail-out did was make a Euro exit, something Greeks apparently don’t want, much more likely. As it happens, Alexis Tsipras, after sacking Varoufakis, looks like a man who’s about to capitulate completely. It would’ve been better had he done so much, much earlier, and not caused such a catastrophe for the ordinary Greek citizens.

*slow hand clap*
There is a theory that all this was deliberate; a means to build socialism in the ruins of post-Euro Greece. But this assumes skills and ability “anti-establishment” parties almost never possess. Never ascribe to malice that which can be put down to incompetence.

This crisis is ultimately the fault of Generations of Greek governments, especially the ones who conspired to get Greece into the Euro by all means fair and foul. It’s the fault of the designers of the Euro who ignored all economic advice and wanted Greece in for silly, romantic reasons: Hellas is mythologised as the birthplace of a European idea of democracy. But the current acute crisis was not inevitable. And the blame for that is the hard-left morons of Syriza and the Greek people who voted for them.

“Democracy is the theory that the common people know what they want, and deserve to get it good and hard.” HL Mencken

If you elect the hard-left, you get a financial crisis. Every. Single. Time. Basically because capital is faster-moving than the people who want to confiscate it. Greece was warned. They did it anyway. The only thing people like Syriza and their supporters are any good at is shifting blame onto anyone but themselves. 

2015 Is Going to be the Best Year in Human History

Last year I wrote some predictions How did I do?

The FTSE100 will reach an all-time high, for the first time since 1999, and will continue the bull-run. 7,000 will be left behind.
Thanks to tightening money, The Oil Price will fall below $100 and stay there. The Brent/WTI spread will narrow from 99/111.

Yup, I spotted the fall in oil price. But I didn’t bet on it, nor did I expect so precipitous a fall. I think the FTSE will break out in 2015

The Labour lead will fall from 6-8%. UKIP will win popular vote in the European parliament elections, then their support will drift back to the Tories thanks to a strengthening recovery. Scotland will vote ‘No’ to independence. Ed Miliband will remain a worthless union stooge. The voter-repelling and emetic Ed Balls will remain shadow Chancellor, because his boss is a spineless dweeb, with shit for brains and “Red” Len McClusky’s hand up his bum. Tories will post a lead, but I doubt it will be done consistently.

Labour’s lead has fallen, UKIP did top the poll in the Euros and are now fading. Scotland voted ‘no’. Ed Miliband’s utter unsuitability for Prime Ministerial office continues to be displayed every day.

The Syrian civil war will not end, but Assad will regain control of much of the country, leaving an islamist insurgency. The world will continue to look the other way.
China’s growth will slow. The rumblings of dissent new riches have smothered will start to grow louder. The Communist Party may seek to use Sabre-Rattling with Japan to detract domestic opinion from the looming economic crisis.
Something dramatic will happen on the Korean Peninsula.

I didn’t really predict anything specific, nor was I far from consensus. But Korea? Was I prescient?

So onto 2015.

  • I think 2015 will be the year the FTSE breaks 7000. One day it will, one day I will be right.
  • Oil will fall to $40, and maybe below and stabilise in the $40-60 range. USA becomes the world’s swing producer
  • The Conservatives will win a thin majority in GE2015. There maybe 2 elections. Don’t ask me how. no polling backs this up. But the country doesn’t want Miliband, and Cameron’s actually done a pretty good job under difficult conditions and doesn’t deserve to be sacked. UKIP to win 3-5 seats, Farage to fail in Thanet, the party’s national vote share in the 10-12% range.
  • China’s growth over the past few years will prove to have been overstated. China’s slowdown to get worse. India to continue to develop rapidly. Modi proving his critics wrong: He may be the man to get India working and taking its rightful place as a major economic power.
  • Russia will try to save whatever face it can for Putin, as it withdraws from Ukraine in response to the falling oil price and continued sanctions. Russia will be set up to rejoin the world financial system in 2016.
  • IS will be reduced to a rump by the end of the year, as having been stopped in their tracks on a number of fronts, they will find the supply of jihadis will dry up.
  • Darfur will be the international flash-point to watch.

We live in a time of miracles. 3-D printed lungs, and people landing space probes on distant orbiting rocks. The benefits of these miracles are unequally distributed. But they do eventually benefit everyone. Luxuries once unthinkable even to Louis XV such as the world’s knowledge at the touch of a button, are available to most, through the miracle of stable institutions, and the creative destruction of free-market capitalism.

This provides opportunity for self-improvement, but also can be a productivity-sucking distraction. Who manages to make the most of the opportunities will set the agenda. Wars end, elections happen. The relentless search for better ways to do things however doesn’t stop. Nations hold elections. But policies can be reversed, or turn out to be right all along. But people keep passing on knowledge, which is accumulating at an ever-accelerating rate. We will work stuff out. In time.

Meanwhile a billion people still subsist by patchy subsistence agriculture. Between the relentless march of new miracles, and the acquisition of already acquired technology by new users, there’s centuries of improvement in the human condition, economic growth, right there. Meanwhile Britain is climbing UP the economic rankings. Real wages appear to be growing sustainably and the growth returns.

Signal to noise ratio, people. Neither the world, nor Britain is ‘going to the dogs’, there’s no need to vote UKIP. 2014 was the best year in human history. 2015 will be even better.

2014 is going to be the best year in human history.

This time last year, I made some predictions: 2013 is going to be the best year in human history. It was, for most of the world at least. And 2014 is going to be even better, for all the same reasons.

How did I do with my prognostication?

The scourge of war is receding from human experience. Though they are still going on, they involve fewer combatants and kill fewer people. As people get richer, and pass through the dangerous middle-income phase, they have too much to lose by fighting.

Alas Mali and the Central African Republic saw crises rise to the level of war in 2013. The civil war in Syria the ongoing wars in Afghanistan continue to claim lives. There have, however been no big, new wars involving western forces. We missed the window of opportunity in 2012 to prevent the disaster in Syria, and it is now too late. I suspect letting Bashar al Assad win is now the least bad option.

Several states in the US have signalled the abandonment of the war on Drugs (well Marijuana at least)

One country, Uruguay, has fully legalised it. The logic of the War on Drugs is waning. Several successful politicians in North America have been caught using Crack and Cocaine, none of whom look like junkies. Dozens of people who clearly aren’t drug-addled derelicts, self-arguing in underpasses, but who maintain busy and high-profile lives have “come out” as having taken Marijuana or Cocaine. It won’t be long before such people no-longer have to pretend to have hated it, or for it to have been a response to an emotional trauma.

In 1963, “some time between the end of the Chatterley Ban and the Beatles’ first LP” people started to admit they like to have sex, and not just for procreation. Rock & Roll became acceptable when in 1976, Glen Matlock of the Sex Pistols said “fuck” on live TV, at a stroke rendering that nice young Mr (now Sir) Michael Jagger, respectable. Perhaps a TV cook with ample curves might be the person whom we can thank for ending the hypocrisy of the drug war. Unlikely. But someone’s going to provide the moment. And soon. A wise man once said….

The world is still getting richer, even if the squeezed middle in the west isn’t.

The giant emerging economies are creating wealth at a rate unprecedented in human history, by the simple expedient of abandoning the socialist choke-hold on creative economic endeavour.

India and China may have slowed, India especially so, but the truth holds. Their Governments have seen the fruits of economic liberalism and seen it work. India may regret electing someone who seems to be an unrepentant Hindu nationalist, Narendra Modi of the BJP in 2014, but it won’t be for his economic policies which are far more business-friendly than the rather corporatist Congress party.

 The poorest parts of the world are the fastest growing. Even if inequality in the west is rising a bit, and that’s debatable, global inequality is falling. 

This is still true, but less so.

So, to carry the game forward, here are some concrete predictions for this time next year.

Money & Business
The FTSE100 will reach an all-time high, for the first time since 1999, and will continue the bull-run. 7,000 will be left behind.
Thanks to tightening money, The Oil Price will fall below $100 and stay there. The Brent/WTI spread will narrow from 99/111.

UK Politics
The Labour lead will fall from 6-8%. UKIP will win popular vote in the European parliament elections, then their support will drift back to the Tories thanks to a strengthening recovery. Scotland will vote ‘No’ to independence. Ed Miliband will remain a worthless union stooge. The voter-repelling and emetic Ed Balls will remain shadow Chancellor, because his boss is a spineless dweeb, with shit for brains and “Red” Len McClusky’s hand up his bum. Tories will post a lead, but I doubt it will be done consistently.

The Syrian civil war will not end, but Assad will regain control of much of the country, leaving an islamist insurgency. The world will continue to look the other way.
China’s growth will slow. The rumblings of dissent new riches have smothered will start to grow louder. The Communist Party may seek to use Sabre-Rattling with Japan to detract domestic opinion from the looming economic crisis.
Something dramatic will happen on the Korean Peninsula.

Happy New Year

There you go. My posts have been sporadic in 2013 as I have less new to say. But I still enjoy writing from time to time, and it’s nice to know my readers, both of you, are still out there somewhere and I hope, whether you come in from RSS or by a random websearch for stewardesses boobs (I still get a lot of hits that way, for reasons that are beyond me) you still think what I say is interesting, provocative, informative or entertaining.

Have a happy new year. And remember risk is to reward as hangover is to party.

Twitter’s first Flash-Crash

Yesterday, some jolly trickster hacked into the Associated Press’s twitter account (@AP) and tweeted

“Breaking: Two explosions in the White House and Barak Obama is injured”

Predictably the market collapsed 0.8%, before rallying on the news that it’s a hoax.

It would be so easy to earn serious money, with almost no chance of getting caught. You need the password. You need to open a trading account for CFDs or Spread-Betting. You need to establish a pattern of trading. You need to have a situation where a $100 a tick position would be entirely normal. You need to open just such a position, shortly before your associate, working from an internet cafe elsewhere, logs into AP’s Twitter and tweets the bogus bomb story.

The fact this happened shortly before the market close suggests the plan was to go long in the final seconds of trading, ensuring another big profit, when the markets open up today on news of the hoax getting around.

As it happened, the hoax was spotted quickly, and the Markets recovered before the close of play. Still, it would be quite possible to make hundreds of thousands of Dollars in a couple of minutes work. This post is of course, an elaborate double bluff.

“Of course I’d do no such thing. Look, I’ve written about it, yer ‘onner.” 

Can anyone get me Reuters’ twitter password?

Labour Plans for Capital Gains Tax

One idiot, Ed Balls, has asked another idiot, Sir George Cox, for ideas to tackle “short-term” thinking in British business. Or maybe I’m being harsh to Sir George. Perhaps he’s just realised there’s good money in telling lefties what they want to hear, and in doing so removing corporate oversight by shareholders. The state, big banks and corporate “business leaders” in a massive conspiracy against the rest of us.

“Short-term thinking” is one of those problems which exists more in the fevered minds of left-wing politicians looking for something to justify state planning, than in reality. And how did that work out every time it’s been tried? Even though state intervention in industrial planning is an idiotic idea, it has been successfully placed into the mouths of “almost three fifths” of “business leaders”. Wow! Just over half of “business leaders” think we should think “longer term”. I am frankly underwhelmed at the support of “business leaders”.

There are problems in some businesses that are too focussed on the next half-yearly report. This is better than the US system where quarterly earnings are the norm. To my mind, 6-months gives shareholders the right level of detail to make decisions. Any company that feels their share price is too low can buy-back shares. Any company that thinks it’s too high, can issue shares. And in practice this is what happens. And in any-case  keeping your shareholders informed of expectations through trading updates and so forth means shareholders are likely to be pretty tolerant of short-term trading problems. The outlook statement is often a more significant driver of the shareprice than the numbers.

Some businesses fail. These problems are not problems caused by “speculation”. Speculative share-buying is an issue looking for a problem. Lefties, like Ed Balls don’t like the idea that someone can buy shares and sell them at a profit. Companies sometimes don’t like the fact that shareholders can run from a company on a profits warning. Chief executives hate the fact they are overseen by thousands of unaccountable people. But good companies, with good products and high barriers to entry get bid up and trade on high multiples (which means their cost of capital is low) and bad companies who’re likely to ask their owners (the shareholders) for more money, or who are likely to go bust trade on low multiples. This means the system is working. Speculators drive this process. They don’t kill companies, they’re the canary in the mine.

Speculators also create liquidity in the market. Liquid shares trade on higher multiples, meaning lower cost of capital, meaning more business investment. If you limit the speculative money, you make markets more illiquid, reduce the price of shares, and increase the cost of equity capital.

Debt interest comes out of profits BEFORE tax and shareholders’ dividends AFTER tax, so built into the tax treatment of companies is a big tax advantage to debt finance. The beauty of  equity finance is that the shares can go down, but the company can go on regardless. Debt can rapidly spiral out of control. Both sorts of finance have their place – I like to see an appropriate level of gearing – but capital gains have, in effect already been taxed at the corporation tax line. If a company has no immediate need for capital, it can ignore shareholders and the share-price. This is not true of debt finance.

So by increasing CGT, you will increase the level of debt carried by companies. You will make companies MORE focussed on short term results, because you can bet your bottom dollar your bank is NOT thinking long-term (and especially the state-owned ones). They are at the moment absolutely focussed on their bad-debt numbers and they will pull the plug on viable businesses long before the end. This is why debt-financed businesses are riskier than equity financed businesses and equity finance better than debt for speculative, risky or long-term projects. One miss of a target, the bank pulls your loan in. Shareholders cannot do this.

Lets look at some examples: Is RBS, a government owned and operated business, whose remuneration policies and semi-annual results are the stuff of breathless news reporting more likely to be thinking for the next headline than, say ITM power, who have spent a decade on primary science and innovation around the fuel cell and electrolyser, but who only started making commercial sales recently?

The proposal to tax capital gains between 50% and 10% depending upon how long they’re held is just stupid, and will reduce the ability of ordinary people to buy into the likes of ITM power. The idea that long-term shareholders are somehow better than short-term shareholders is risible, and bears no scrutiny. Long term shareholders tied in by CGT rules will not be able to influence the company at all. Short-term shareholders vote on the company by buying and selling the stock. Liquid stocks are less volatile.

All this stupid, facile, imbecilic proposal will do is further increase debt finance over equity finance. Any influence small shareholders have will be lessened. This is just the state regulating for the benefit of big corporate bosses who prefer to deal with large institutional shareholders. This is just mindless corporatism that will worsen corporate governance, increase costs and decrease liquidity and therefore increase volatility of stock.

An aggressively tapered CGT regime will at a stroke make worse the problems it is meant to solve, and anyone thinking it’s a good idea should be sedated and kept away from sharp objects. Of all the ideas to come out of the Labour party, this is the most obviously stupid for some time.

Compliance and the Myth of Goldilocks

So far, in the last few years, there have been a number of co-incident enormous financial scandals, which reached from the macro, to the micro, top to bottom. You have various mis-selling scandals. Zero-Dividend preference shares, Endowment mortgages and PFI insurance to name a few. You have LIBOR rigging. You have sub-prime mortgages in the USA, and “liar’s mortgages” in the UK. You have a BASEL II capital adequacy regime. You have mega-mergers and the growth of international financial institutions with liabilities so large, they bankrupt the states which stand behind them.

All of this happend despite the rise of the most intrusive compliance regime the financial industry has ever had to endure. There were rules from everything to the type and amount of assets to be held on the balance sheet, measured in billions, to how quickly any given institution answered the phone. To argue therefore the catastrophe which has engulfed global finance since the 2007 is the fault of de-regulation, is absurd. 

I argue the opposite. I argue the strict compliance regime is the ultimate CAUSE of the crisis. Because banks went bust occasionally in the past: BCCI, and Barings, as the result of fraud or rogue traders, but they did not pose the systemic risks of RBS or Lloyds.Why not? 

To understand, we need to go back to  The US savings and loan crisis of the 90’s, which triggered the recession of 1990-1991. The end of the recession in 1992-1993 following the state bailouts of large numbers of institutions may have made the recession less severe, but it sowed in the mind of the people lending money, that the Government would ride to the rescue. Having ridden to the rescue, Government for it’s part decided to interefere in the lending decisions of banks.

Bureaucrats have tidy minds. To them, the chaos of the market is riskier than the ordered marching of Giants. Since 1990, the number of financial institutions lending money, halved. Regulators encouraged mergers. Savings and loans and regional banks were gobbled up into behemoths. A process which was repeated with equal enthusiasm on our side of the pond. Slowly, the institutions grew. The housing market picked up steam, and ushered in the Clinton “goldilocks” economy of the 90s. 

Almost every financial asset class became more expensive. Bonds had been enjoying a bull market since the late 70’s carried on running, and the yields kept falling with low interest rates. On those, more later. Equities ran up towards the bubble, which eventually popped in 2000. Property rose steadily from the early 90’s. Money flooded into Government coffers. People felt wealthy on their rising property and took on more debt.

Regulators and politicians congratulated themselves on this state of affairs. They responded to the Stock-market crash of 2000 with lower interest rates, to keep the economy going as investment from the private sector dried up. Instead of allowing the mal-investment in the lastminute.coms and other businesses valued on insane multiples of EBIDAWM (Earnings before Interest, Depreciation, Amortization, Wages and Marketing, AKA “sales”) to be purged, that mal-investment was replaced by Government spending, most of which disappeared into lower productivity and higher pay. Low interest rates stoked a property boom all over the world. Banks kept getting bigger, with more liabilites. And with scale came Government interference.

In the USA, banks were instructed to lend to poor credit risks, through the community re-investment act. Bush senior and Clinton allowed banks to securitise these mortgages, and other non CRA “sub-prime” (which then had a more positive meaning – just below prime, ie good). Slowly institutions relied on the prop of the rules. The packaging and re-bundling of debt was a creature of the abnormally low interest-rates driving a frenzied demand for credit, right through the income spectrum. UK banks relied on wholesale markets rather than their depositors. Anything which was allowed was OK, without any real understanding of the risks. Everyone assumed, just like those selling endowment mortgages in the 90’s that the assets would just keep going up.

Volatility was taken as a proxy for risk. The CAPM and VAR measures took volatility for previous years and fed it into a model, which spat out acceptable numbers. Of course, as Naseem Taleb explains so elequently, Returns are not normally distributed, the key assumption behind CAPM. Tail risk, the risk of massive unforseen losses are orders of magnitude more likely than predicted by Gaussian mathematics. “6 Sigma Events” like black Wednesday, the LTCM crash and the .com bust which should happen once every 100 million years or so, happen every decade. Just because the distribution of natural phenonomena from penis length to life-span obey Normal Distributions it does not follow that financial markets do so.

However with the regulator happy with ever increasing risk, and everyone from individuals to Governments frenziedly gearing up with debt, the regulatory bureaucrats were applying box-ticking metrics without really having any deep understanding of the businesses they were regulating. Banks got on with making money, but like all institutions became too big to manage effectivly. And they were making money in an environment where the political pressure was entirely RISK ON! While CRA mortgages in the USA were not the worst from a default point of view, the environment in which the legislation was created was one where the politicians encouraged banks to lend in order to get voters onto the property ladder. The because the politicans had achieved growth without inflation, they thought they could “eliminate boom and bust” and encoruaged the banks and regulators to behave as if they had.

Certainly that’s what Gordon Brown thought as he, most egregiously, spent the tax-recipts from a booming economy, and borrowed even more, and spent in the assumption that his genius would keep the wheels turning, turning the most solid balance-sheet in the developed world into a social democratic Euro state with fat welfare and soggy competitiveness, like Germany (who in the mean-time was keeping interest rates up, and wages down, marching in the opposite direction).

Of course the .com bust in 2000 heralded the end, though it took 7 years for the ever lowering interest rates, which was the inevitable response to every piece of poor investment or GDP data, to lead to a crash, it is this that is responsible for the property boom, the government overspend and the catastophic finanacial crash. And this was made all the worse for because a system with a few large, systemically important institutions may appear easier to regulate, but is in fact more vulnerable to the storms.

The .com crash caused a recession that never happened as private sector investment dried up, to be replaced by government spending on war and diversity outreach co-ordinators. The boom continuing on Government spending and consumer debt. Debt that ultimately sat on banks’ balance-sheets either as “capital” – Government bonds, or as books of loans.

And because of the tight regulation, they were all carrying the same assets, in the same proportions according to the same risk metrics as each other, funded largely from wholesale markets. And when HSBC announced that a surprising number of its US mortgages were going bad in 2006 (about when “sub-prime” took on its current meaning), the writing was on the wall. Those books of loans propping up the system were not worth what people thought they were worth.

Financial markets are prone to panic. It is a chaotic system, and as such does not lend itself to regulation, especially if that regulation is based on volatility. Beta, in a crisis, tends towards 1. This means all financial assets, however diversified in normal times, crash toghether as everyone tries to unload them at the same time. It takes two views to make a market. Regulators, however insist on one view in a catastrophe, and often make things worse. Instead of attempting to remove risk by making entrepreneurs and risk-takers behave like civil servants (they won’t), better to let them face the consequences of their actions. Regulation should instead focus on making the system resilient to the inevitable storms. And that means smaller institutions, and more acceptance of differing approaches, the absolute opposite of 15 years of financial regulatory practice. Instead, every bank in the world tried to do the same thing at the same time and the finance system dried up.

No-one is suggesting NO regulation, but ultimately the best regulator is the market. Perhaps a bit more diversity in the system, and more but smaller institutions would be more resilient? The only thing I am sure of is what ever the answer may be, regulators do not have it. Unfortunately they think they do, and seek to impose the same solutions on everybody.

At present, my little corner of the industry is undergoing a bout of regulatory hyperactivity. The retail distribution review is busy setting out what can be sold to whom. Customers are being categorised by risk appetite. Those with low risk appetites are expected to invest almost entirely in Government bonds.

I am being made to sell Government bonds yielding 0% at the 2-year point guaranteeing a 3% annual loss to inflation because Government debt is RISK FREE. Of course we only believe that because we’re at the end (inevitably…) of a 30-year bull market. Just as the misselling scandals and credit crunches are a creature of the regulatory environment, I can see the howl of pain when interest rates start to go up again, from Governments paying the interest, and those investors whose “advisers” have  been forced to sell them shitty Government stock. I can see the misselling scandal on the horizon.

Retail financial regulation should be someone slapping customers with a fish, while shouting “CAVEAT EMPTOR” through a loudhailer. Macro-regulation should ask one question: “how fucked are we, if this bank goes bust?” If the answer is “very”, then break the bastard up, and say “NO!” When it tries to buy NatWest. Regulators should not try to run banks or investment portfolios. They should protect the investor from fraud, and the tax-payer from “too big to fail” and that’s it.

Instead, why are people still getting paid out on RBS bonds? Why does RBS even still exist to pay Hester his bonus? The only people who should have been bailed out, are the depositors, not the management caste. QE? Only benefits the banks, whose top executives are still being remunerated in bureaucratic style, according to headcount. The only guy to crash through the system and save his bank from the tax-payer in spite of the idiot regulator, was Bob Diamond, a hero and worth every penny of $20m. Yet he’s painted the villain!

Why not try a helicopter drop? defend depositors, smash investors in banks. Instead of supporting institutions which failed, why not support people? In every instance, the regulators favoured the tidy, mega-institution, rule-based status quo, when they should have let the market do its savage work. Markets encourage diversity and strength. Regulators create a monoculture, vulnerable to the first illness. 

Markets kill bad banks. Regulators prop them up. Here endeth the lesson.

Stella Creasy & The Loan Sharks

Let’s take a chap, me, who’s overspent in a month (on mandatory, regulator-imposed exam-fees, as it happens but also on a holiday for the bird, a bike for me and a really rather extravagent piss-up in which I lost all sense of proportion, and mistakenly let my ‘friends’ loose on a tab). The Fee from the bank to go over an overdraft limit: £25 plus additional fees of £5 PER DAY over 9 days, this would be nearly £70. by comparison, the cost of a £200 loan from for 9 days £23.74.

Stella Creasy can work out that the £23.74 fees & interest on a £200 loan is an APR of 481%. This she thinks is terribe. By comparison, if the payday lender were not there, the APR to the chap who’s overspent is 1,419%, which he would have no choice or ability to avoid. Yet again, the tighter regulation suggested by fucking morons drive people into the tender embrace of the banks who make an absolute killing. One may be paying an APR of 481%, but I’m saving £46.26. Of course the solution is to not go over your limits, but when you do, would you rather pay £23.74 or £70?
Regulation favours the banks, over insurgent competition. Again.

Update. I had a conversation on Twitter about this with the MP in question, who came accross as ill-informed and rather smug. OF COURSE, FINANCING YOUR LIFE USING WONGA IS STUPID. The assumption that this service is bad, and exploitative is made a-priori, without considering the costs of offering a £200 loan for 2 weeks for less than £30 to people who are, by definition struggling for money. Meanwhile Twitterer, @rfrst was trying in vain to make the point that 1% a day plus a fiver is a HUGE APR, which in no-way reflects the cost of borrowing. Wonga for exampe, don’t compound the interest, so APR is an absurd measure. I pointed out that other short-term lenders do not enjoy a big return on equity, so they’re not making abnormal profits. It’s true, a lot of money is spent on advertising. But that’s inevitable in a new sector with low barriers to entry.

All I got from the MP from Walthamstow was ad-hominem and a-priori statements not backed up by argument, logic, reason, or economic rationale. Worse, she refused to admit that limiting the cost of credit would affect supply. Finally, she seems to think credit unions are a solution. They are, to those on the carousel of debt, or who are looking to finance purchases more effectively than store credit. They are not a replacement for Payday loans, because the money isn’t instant, and so cannot be used to avoid bank debt.

Rather than going after the reputable, and reasonably well-known Wonga, it would be better to go after the less reputable lenders who do overcharge, make multiple claims against an account in a day. Better still, go after the banks, with whom APRs of over 1,000,000% are possible.

How Financial Regulation “Works”.

So, you’re a stockbroker, and you’ve been in the game now for over a decade. You’ve got some fairly serious book-learning under your belt, and have experience across a wide range of businesses including buy and sell-side analysis, sales-trading and futures trading. You’ve been at your current desk for 7 years, and you guided your clients through the crash with some success.

You’re not unqualified. The business is not unregulated. There was no systemic problem in the private-client stockbroking business.

However there was a crash. And lots of people lost money and are looking for someone to blame. The economy is stagnant (though this is mainly due to pre-crunch crowding-out coming home to roost). Everyone in the financial services industry without a regional accent and a job in a call-centre, is a “banker”, and so “a cause of the crisis”.

Something must be done“, said the politicians, without having the vaguest notion of what it was they wanted to achieve. So they asked the FSA to “do something”. So the drones of the FSA, who regulated the banks so successfully over the past decade, asked the Professional bodies like the ‘Chartered Institute of Investment Management’ and the like, whether further regulation of the investment advice industry was needed.

YES!” screamed the professional bodies. “All brokers need to be a member of Professional bodies [us]” they said with a straight face, “and they must all take lots of Exams [provided by us, for which we will charge many hundreds, knowing these people have no choice but to take them or lose their jobs]”

Anything else?” Asked the failed banker with a 2:2 in media relations from Hull, who was rejected by the investment banks he really wanted to work for, instead of the FSA.

Certainly. the brokers need to spend many hours logging their ‘continuous professional development’ on our system, so we can sign off their competence each year, by issuing an annual piece of paper called a ‘Statement of Professional Standing‘, but only if they take lots of courses [provided by us, for which we will overcharge]”.

That seems a lot of work” said the FSA-wallah, overcome with sympathy for the non-problematic part of the financial-services industry which forms his bailiwick “won’t that take them a lot of time they could spend blogging tending to their client’s needs?

No” lied the professional bodies. “This will improve the customer experience. All exams are good [even though we’re STILL teaching them the CAPM which is, put simply, bollocks]”.

The FSA-wallah reports back to the politicians that the regulation of investment advice is in hand. “This is something“, say the politicians. “Let’s do it“.

Thus financial regulation gets more onerous, time-consuming and expensive. Clients will see higher bills, and find it harder to speak to their broker as he will be doing his mandatory 35 hours of logged annual CPD or inputting it into his chosen Professional body’s computer system. It not being worthwhile to go through the process above for small clients, if you want advice, you’d better have serious wedge to invest, or you’re on your own.

If you want a perfect example of regulatory capture working against the interests of (especially less-wealthy people), this is it.

The Retail Distribution Review is the most counter-productive piece of legislation I’ve ever seen. It’s a Vicious, savage, bureaucratic, insane, corrupt over-reaction to a problem which doesn’t exist. It will virtually ban those on average earnings from receiving decent financial advice. They will be driven instead into the arms of the Banks who will sell them “products” whose performance is utterly opaque, larded with fees which will be virtually impossible to get out of. The banks will call this “advice”, but you will never see or hear from the hair-gel and bri-nylon school-leaver who sold you the “product”, ever again.

You think the Banks fear tighter regulation? No. They want it. They lobbied for it. They NEED it. Regulation protects them from the likes of me. Wicked.

A Layman’s Guide to the Euro Crisis.

There is a lot in the news about the crisis in Europe, and a lot of the coverage is filtered through political lenses as people project their beliefs onto what’s going on. Eurosceptics are enjoying saying “I told you so!”. Left-wing parties are blaming the banks and the political right is seizing an opportunity to ‘shrink the state’. It’s often difficult to separate fact from journalistic wishful-thinking. So what’s really going on?

The EuroZone is a ‘currency union’ without a ‘fiscal union’. ‘Currency union’ means sharing the same currency. The 50 States of the USA are in a currency union with each other, and so are the nations of the UK. The EuroZone is a currency union between some European Union nations.

A ‘fiscal union’ is where a central government makes spending decisions for a currency area. Despite devolution in the UK or the American states’ tax and spending powers, the USA and UK are ‘fiscal unions’. The American Federal government distributes funds from a central pot to the individual states to spend on things, such as roads or law enforcement. In most fiscal unions, richer areas pay more tax, but don’t get more state spending per head than poorer areas, resulting in a ‘fiscal transfer’. Some ‘entitlements’, what people in the UK would call ‘benefits’ for example are paid out of a federal pot. In the UK, the greater South East subsidises the poorer areas of the UK by this method.

In the EuroZone, many thought this union would cause problems, and indeed the designers of the currency knew this too, but considered the problems would act as a driver of ever closer union, their ultimate end aim. The Euro was a political, not an economic construct.

What precipitated the crisis around Europe was the inability or unwillingness of Northern Europe to subsidise the periphery in the way London and the South East subsidises the rest of the UK. As the periphery ran out of money, and succumbed to financial crises, one-by-one the markets lost faith in the ability of these governments to meet their debts.

Governments issue debt as bonds. If investors think the risk is low, they will be willing to pay a high price, resulting in a low yield to the investor and low costs to the borrower. If the risk goes up, the price falls, and the yields rise. Countries afflicted by the financial crisis saw bond yields rise as investors sold. The money investors raised by selling this debt flooded into the good risks at the core – especially Germany, which has seen yields fall sharply as a result. The UK and Switzerland have enjoyed a similar effect, being perceived as safer-havens. This rapidly became a self perpetuating downward spiral for the bonds of the afflicted governments.

The problem with the Euro is that small countries or those which had poor track records of paying back debt, suddenly saw their borrowing costs fall when they joined the Euro. This is because the markets initially thought all EuroZone bonds ranked equal, or nearly so, to those of Germany. Because the peripheral governments’ borrowing costs fell, so too did those for business and consumers. This resulted in banks lending and people borrowing much more than they would otherwise have done. Some governments, notably Greece, fell into the same trap too.

In Ireland and Spain in particular, this very low interest rate resulted in a huge speculative property bubble as a flood of new money inflated property prices. People got rich very quickly, and numerous new developments were built. However all bubbles must burst, and the oversupply of property meant there was insufficient demand for all the new flats and houses. The market crashed. The bad loans secured on overvalued property created losses which overwhelmed the banking sector. The Irish government, despite the fact it had been ‘fiscally prudent’, by running large budget surpluses during the boom was also overwhelmed. In 2007, Irish debt was just 25 per cent of gross domestic product (GDP) – a measure of the size of an economy. Despite this, the Irish state, unlike that of the UK, simply didn’t have the line of credit to finance the enormous banking losses, and needed help from the EU and UK. Because of the banks’ losses assumed by the Irish state, debt to GDP ratio has now risen to nearly 100 per cent.

Portugal, however did not suffer such a crisis, as it lacked a big banking sector of its own, so much of its property bubble was financed from across the border in Spain. However the Portuguese government didn’t run significant surpluses in the good times, and when the economic crisis came, tax receipts fell, and the market lost confidence in the government’s ability to pay its debts. As the country was running a large deficit, when interest rates hit 7 per cent, a burden totaling 80 per cent of GDP, the market considered this unsustainable. The EU & International Monetary Fund was forced to ride to the rescue.

Spain, being a larger economy than Ireland, took much longer for the bubble to deflate. Its banks were also sounder, carrying more capital than Ireland’s. Like the Irish, the Spanish government ran a prudent surplus during the boom, but it too may now struggle to raise sufficient money to bailout its banking sector, which has suffered the same fate as Ireland’s. As a result, Spain needs a bailout. And the EU has made €100bn available. Because it is not clear whether this is from the European Financial Stabiliity Fund (EFSF) or European Stability Mechanism (ESM), existing holders of Spanish debt are unsure whether the new creditors are ahead of them in the queue for repayment. Investors fear they have been ‘subordinated’ by the new line of credit. As a result, after brief euphoria on the markets, borrowing costs in Spain and Italy rose on the news.

Italy did not have a property bubble, nor did it have a banking crisis. Instead, it enjoyed a cheerfully chaotic political system which was incapable of balancing its books. Short-lived governments had little incentive to save money, finding it easier to buy off supporters without taking long-term decisions. Their problem as a result is simply an enormous debt burden of 130 per cent of GDP. Currently, Italy is running a ‘primary surplus’, that is, it is able to meet its costs – public sector wages and so on, and would be able to balance its books, were it not for debt interest. Italy’s budget deficit is therefore a direct function of the yield on its bonds. Perversely, this is the moment countries are most likely to default, as they will not need to tap the bond-market to meet existing expenditures. As a result, investors have fled Italian debt in a self perpetuating downward spiral in their bonds and increasing the likelihood of default.

Greece’s problems can be summed up as ’all of the above’, and then some.

As a result, everyone in the EuroZone is seeing their borrowing costs rise, except the dwindling core of Northern European AAA rated countries. Even France isn’t safe – they haven’t had a balanced budget since the early 1970’s, and borrow at nearly twice the price of Germany.

The UK’s debt burden is 80 per cent of GDP or so (worse than Ireland in 2010), a deficit in 2010 of 11 per cent (the worst in the developed world) and an enormous banking sector relative to GDP. So why doesn’t the UK have a massive economic crisis like Ireland, Italy and Spain? Why is UK 10-year debt yielding a paltry 1.8 per cent when equivalently indebted countries with far smaller deficits find their debt yielding over 7 per cent? Ultimately, it’s because for the time being, the debt markets have confidence the UK can meet its obligations, if necessary by printing money. This option is not open to the EuroZone, who have subcontracted this to the European Central Bank. Furthermore, the UK’s government debt has a much longer maturity than many equivalent countries, so does not need to access the bond market to ’roll over’ maturing issues, giving the UK’s government time to bring the finances under control. Finally, and this is almost certainly the least important effect, the UK’s government is committed to gradually cutting the deficit.

The EuroZone therefore is suffering from the logic of a ’currency union’ without ‘fiscal union’. As the breakup of the EuroZone looks increasingly possible, bank depositors in Greece (most urgently), Portugal, Spain, and Italy do not want to risk waking up one morning to find they’re holding Drachma, Escudos, Peseta or Lira instead of Euros. So they open bank accounts in London, Geneva or elsewhere in currencies – Euros, Dollars, Swiss Francs or Sterling which they trust to remain ‘hard’, and where their cash-strapped governments can’t get at it.

This causes a collapse in the money supply – often a cause of deep recession. Unlike in a ’fiscal union’, this money is not replaced by transfers such a grants paid out of EU pooled funds, which are simply not large enough to do this job. As the economies of the EuroZone periphery shrink, so do tax revenues. With no corresponding shrinkage in obligations, the deficit can only rise. Spending cuts cause further short-term pain as public-sector workers get laid off, and the economy risks spiraling down. Wages, for those who retain jobs get cut and living standards fall. This is the mechanism by which ’austerity’ is accused of driving economies down.

Unfortunately, for the citizens of the EU, from an economic point of view this fall in living standards and wages is exactly what is needed. The underlying problem is competitiveness. Italian workers are just more expensive than Germans per unit of output. Italians’ wages have to fall by around 20 per cent to regain competitiveness, Spaniards by 30 per cent and Greeks by 50 per cent.

The Italian economy was never really as large as the UK’s, nor were Italians as rich as Germans. They just got access to Germany’s credit card for a decade and so thought they were. Bringing the economy back to reality will be a painful process. This is called an ’internal devaluation’. It will be miserable, and scar the people forced to endure it for life, and result in a flight of talent and capital, from places suffering its effects. An internal devaluation on the scale needed may not be possible without violence.

Devaluation of the currency means most countries overcome these effects, and make their exports and workers competitive. It’s worked for the UK many times, but for the periphery, this means leaving the Euro. A new Drachma would probably fall by 50 per cent almost immediately, achieving competitiveness with the German worker in a matter of months rather than years. This is no easy option though, either from the point of view of the Greeks who will see imports, even of staples become prohibitively expensive; or the rest of the EU. Once the market has forced one country out, the next one (Portugal or Spain) looks more likely to go too, creating a cycle of instability. It is this EuroZone policymakers fear the most.

If Southern Europe is to remain in the Euro, and yet avoid grinding recession for a decade or more sudden economic catastrophe, it is going to need vast injections of cash to pay the bills. It also needs its productivity and wealth to catch up with that of Germany and Northern Europe. For an idea of the scale of cash transfer needed, look at fiscal transfers from the North to the ex-Confederate states after the US civil war, or from West to East Germany after unification. 10-20 per cent of GDP. It is unlikely the (West) Germans can be persuaded to pay on that scale again. Nor do Germans seem willing to underwrite the deposits in EuroZone banks (a so-called banking union) or underwrite the bonds of the struggling EuroZone states (the so-called Eurobond).

People describing themselves as ’Keynesians’ think the death-spiral of austerity and internal devaluation can be averted by governments injecting demand into the economy by borrowing huge sums in order to spend. Who is going to lend to these peripheral governments? The German government seems unwilling to let the European Central Bank print enough money and the open market has already said “no”.

It is not a binary choice between ’growth’ and ‘austerity’. Even if these governments could raise the money, they may not achieve the necessary growth. There is evidence that the negative effects of increased public spending can cancel out any stimulus to the economy. Public debt often ‘crowds out’ private investment. High debt burdens may also cause people to anticipate future tax rises and rein in spending and increase their savings which will hurt the economy. These negative effects seem to become greater than the positive when the debt burden reaches 80 per cent of GDP, though this is not a hard and fast rule. Furthermore, economies seem to find any growth at all very difficult to achieve if public debt reaches 120 per cent of GDP. Thus, attempting to spend your way out of recession, an indebted Government risks fruitlessly adding to the debt burden, to no effect on overall GDP growth.

It seems the money for stimulus has probably already run out.

In my opinion, the best thing to have done is to not join the currency union in the first place! The UK’s ejection from the European Exchange Rate Mechanism in 1992 and Iceland’s experience since 2008 seem to bear this out. ’Austerity’ and the devaluation in place is painful, so ’stimulus’ is superficially attractive, but it risks creating a bigger problem for the future for little gain now. The unfortunate conclusion is what is necessary is impossible, and what is possible is unappealing. There are simply no easy answers. The Euro crisis is likely to form the backdrop to investment decision for some time to come.

Why is the Stock Market so Reslient?

First there was an agreement, to widespread euphoria, then Greece (all but) rejected it and the market fell. Then the ECB cut rates this morning, and the stock markets rose. What’s coming up in the next few days? Well most importantly US unemployment numbers called the non-farm Payrolls are tomorrow. I expect these to be good, given the strong (these things are relative…) GDP numbers from the USA last week. Either way they could Move the market significantly.

Compared to August, the market’s looking pretty resilient. This is because of continued strong corporate earnings, backed by mainly strong cash-flows. Many companies have little debt on their balance sheets, and most UK banks are well-capitalised, even if the Government owned ones are merely stable in intensive care.

I expected last Thursday’s Eurozone deal to kick the can a little farther down the road than 4 days, and now Italy is in the market’s sights. While Greece, whose government has collapsed, and who appeared threaten a military coup at one point may dominate the evening news, it is the relentless rise of Italian bond yields that is the main cause for concern. Financially speaking, Greece, 1.6% of Eurozone GDP doesn’t matter, and the banks (or at least all but the French banks) have already written down their Greek debt to 50% – they have ALREADY taken the loss. The Eurozone tax-payers through the ECB and the EFSF have yet to do so, mainly because politicians don’t want to explain how they set fire to €1tn to their electorates. This is politics. As far as the markets are concerned, Greece HAS defaulted. It’s over bar the shouting.

Italy on the other hand has the Worlds’ third largest bond market and much of this is held by systemically important financial institutions. A default could spell a run on Italian banks, and the complete failure of the Eurozone. 10y Yields are now 6.5%. Even Spain is holding steady at 5.45% and Portugal at 5%. Ireland is Yielding 8.5% and falling. Worse, French bond yields have started to rise. That we are talking about an Italian default is remarkable given they are running a primary surplus – that is to say the Italian budget is balanced before financing the debt. They have, by this one measure a stronger set of public finances than the UK. The difference? The UK can print any money necessary to service its debts and our debt is of much longer maturity meaning less falls due needing refinance in the near future.

So far the European Central Bank has ruled out the one course of action it could take to isolate the bankrupt countries: indicate that they are standing behind (French – though this is already assumed) Italian and Spanish debt with printing presses if needs be. It is just a matter of time. Until they do, there will continue to be bad news and the longer they leave it the worse it will be.

Finally, it should be remembered that the UK economy and even more so its stock market is tied to the USA, not the Eurozone. Our economic correlation to the USA is .95, almost as high as such things could possibly be. Thus even the disaster of Italian bond yields is probably less important than the Employment numbers from the USA, and the USA is recovering steadily as is the UK whose Q3 GDP numbers indicated a slight pick up from a summer stall.

This is why the UK stock market is 15% off August lows. Bankrupt governments in Athens and Rome just don’t affect business that much. Yet. A stagnant US economy would be much more worrying.