RBS exercises restraint

First the bad news. RBS chairman - Sir Philip Hampton, conceded that last year more than 100 employees received compensation of at least £1 million. The good news is that the number was lower than the preceding year.

There is even more good news - bonus pool was less than £950 million. It could have been so much higher.

Stephen Hester, chief executive, summed it up perfectly "We have tried to exercise restraint."

How cheap dresses and shoes led to the financial crisis

Fashion has never been cheaper.

Since 2000, the ratio of clothes and footwear prices to hourly earnings fell by almost 60 percent. Around half of that decline was due to the direct effects of lower prices; the other half came from higher nominal wages.

This chart illustrates this spectacular fall in the real price of clothing. It also demonstrates the extraordinary structural change that has occurred in the world economy over the last 10 years. There was a time, and it wasn't so long ago, that Britain had a textile industry. That industry has all but disappeared. Instead, all our clothes are produced overseas, mostly in East Asia, particularly in China.

Loan shark who charged 2,437 per cent

Obviously, Mr. Kiely didn't hear about the Bank of England's zero interest rate policy. From the Telegraph....

John Kiely, a loan shark, was branded a "ruthless individual" by a judge in Manchester as he was jailed. Kiely, 36, was sentenced to five years at Manchester Minshull Street Crown Court for offences including blackmail and illegal money lending.

Judge Adrian Smith told multi-millionaire Kiely: "It's clear to me you are a ruthless individual who has displayed a high degree of criminal sophistication." Kiely charged up to 2,437 per cent interest on loans and used an army of enforcers to collect debts owed by poor families on Manchester housing estates, the jury that convicted him last month heard.

One of his victims, Donna Ockerby, 45, claimed she was left fearing for her life and was forced to move to a secret location to escape him. Kiely was convicted of two counts of blackmail for his actions towards her.

Mrs Ockerby, an auxiliary nurse, borrowed £300 from "Johnny Boy Kiely" to pay for her wedding dress in January 2007 because she was "absolutely desperate", the jury heard. He dispensed the money from a roll of £20 notes from his black Range Rover, complete with the personalised number plate "B0Y".

Mrs Ockerby said she faced aggressive demands for money when she struggled to repay her debt because her working hours were cut. On one occasion Kiely turned up unannounced at her semi-detached house and grabbed hold of her. Another time he turned up and banged on her door early in the morning, the court heard. Mrs Ockerby told the jury she feared for her life when a concrete block was thrown at her window just hours after a debt collector called.

Government considers guaranteeing mortgages

Is there no end to this madness? Why should a renter have her tax receipts used to subsidize a first time buyer who wants to buy a home?

Why doesn't the government consider subsidizing rents? Why not offer guarantees for any renter unable to pay their rent? That way, I could find the big house somewhere in Hampstead, which I can't afford, rent it, default on my payments and then hand the bill over the Her Majesty's Treasury.

This proposal to guarantee mortgages would be so unfair. In fact, it is inequitable. I wonder whether Ms. Harman's new equality legislation could be used to outlaw this kind of guarantee?

From today's Guardian....

First time home buyers could be thrown a lifeline under plans being considered by the Treasury to underwrite 'risky' mortgages, allowing people with only small deposits to buy homes.

Since the credit crunch took hold, banks have demanded far tougher criteria for lending, asking buyers to provide between 25% and 30% of the price of a home as a deposit.

There were 30,000 loans to first time buyers in the first three months of 2009 against an average of more than 100,000 a quarter in the previous decade.

Decision time on quantitative easing

The Bank of England have almost exhausted their authorization to print cash to buy up assets. As of July 23, the Bank of England had purchased ₤121 billion of government bonds, commercial paper, and corporate bonds. The government had authorized purchases up to ₤125 billion under the asset purchase scheme.

Of course, the Bank of England can go back to the government and ask for an increase in the amount of cash it can print. However, ₤125 billion is a huge number. Asking for more would only further increase the risk of an explosion in inflation two or so years down the line.

In terms of kick-starting the economy quantitative easing has yielded dismal results. The economy continues to decline. GDP has now contracted for five straight quarters. Since the recession began, the UK economy has shrunk by almost 6 percent.

Quantitative easing hasn't done much to boost credit; at least not so far. Lending to the corporate sector continues to decline, while consumer credit is flat. It is only the housing sector where we have seen any tangible results. Mortgage approvals are up and credit conditions are improving.

However, the policy of printing money and buying government debt has had one notable success. The Bank of England has used its QE authorization to buy up over ₤118 billion of gilts, allowing the UK government to run up the largest fiscal deficit in history.

Bank interest rate mark-ups increase to a 20 year high

Well, someone has to pay for those bonuses.....

Credit card debtors generously help out the banking sector

The Bank of England may have cut interest rates, reducing funding costs for banks, but you won't see that generosity extended to credit card debt serfs. The spread between LIBOR and credit card interest rates has increased by well over 600 basis points.

It is probably a good thing, hopefully discouraging a further unsustainable increase in household debt. Also, the increased spread presumably increases the profitability of credit cards, and helps banks cover their huge losses speculating on those hopelessly mis-priced asset backed securities. In effect, credit card debtors are providing their very own bank bailout.

Personally, I am grateful to those credit card debtors for this generous assistance to our beleaguered banks. It means less of a burden for taxpayers.

US home sales are flat

Flat as in pancake....

Goldman Sachs are Scum

Tell us what you think about Goldman.....

The bubble is back in Beijing

Just wait, the bubble will be back in London. A wall of liquidity from the Bank of England, coupled with zero interest rates - that should do the trick....

From Moneyweek.....

"Beijing has prescribed a strong remedy" for the Chinese economy by flooding it with money, says Wei Gu on Reuters.com. Since lending restrictions were removed in November, outstanding loans are up 30% year on year.

This flood of money has buoyed asset prices: the Shanghai stockmarket is up 69% since the start of the year, while investors are now returning to the property market after the government clamped down on an emerging bubble there in 2007. Today, "long queues increasingly form whenever new apartments go on sale" in cities such as Shanghai and Shenzhen.

After a tough 2008, "the worst is over for the residential property market", says Feng Zhi Wei of Standard Chartered. Sales volumes are up, while prices have stabilised. Even in a downturn, buyers have been willing to re-enter the market now that costs have fallen far enough to be attractive. But don't bank on a rapid price rebound. "Buyers – especially at the mass to mid-end – are mostly price sensitive and are likely to hold their purchases if house prices fall outside their affordability levels again."

Another crazy US banking chart.

Have US banks made sufficient loss provisioning to cover their loans? This chart tells us that they haven't.

First, a warning, this is a difficult chart to explain and understand. However, it is well worth the effort to see what it is telling us about the US banking system.

So here goes....

The US Federal Financial Institutions Examination Council assesses whether banks make sufficient allowances for losses. In the bank supervisory reporting system, this number is called the "allowance for loan and lease losses" or the ALLL.

In order to make this assessment, the FFIEC looks at each bank and divides the ALLL by non-performing loans. If the ratio is greater than one, then the bank has things covered. If it is less than one, the bank has insufficient provisioning.

Here it gets a little more complicated. There are big banks and there are little ones. This chart takes account of that rather obvious fact. It separates those banks that have a ratio greater than one from the under-provisioning banks. It then takes the sum of all assets held in those good banks and divides it by the total assets of the banking system.

So what is this chart telling us? Currently, only 19 percent of assets are held in banks that have a ratio greater than one. In other words, the US banking system as a whole has insufficient allowance for losses.

This is why US banks are scrambling to increase their loss provisioning. In turn, provisioning is costly, and this is going to keep the US banking system severely depressed for a long time to come.

Another beautiful chart

This financial crisis has produced some wonderful charts. Recent numbers either dive to the depths or reach for the sky.

I particularly like this one. It illustrates loan loss reserves of US banks. The reserves are expressed in terms of total loans.

The chart tells us two things. During the boom years, banks ran down the spare cash they put away to cover bad loans. Just before the crisis they were putting away barely one percent of their total loans.

Then, along comes the crisis and banks suddenly realise that they don't have enough reserves. Everything goes into reverse, and banks start accumulating reserves like crazy.

I reckon this number can only go higher. Soon, it will exceed the previous highs in the late 1980s, and hit an all time high.

Krugman versus Taylor

Taylor comprehensively out-argued Krugman on the deficit, but Krugman hit hard on US healthcare reform.

Keep on doing what you are doing

There were many reasons why we got into this crisis; poor financial sector regulation, distorted incentives, bonuses, speculation, excessive risk-taking. However, there is one reason that doesn't get enough attention; the policy remit of the Bank of England.

When the BoE became fully independent, the government gave it an inflation target. It said to the bank "go chase down the consumer price index. Make sure it doesn't increase by more than 2 percent a year". Ominously, the government didn't say keep asset prices under control and avoid speculative bubbles.

The BoE happily went along with this new target. Keeping inflation under control would be easy. Moreover, the Bank added an air of modesty to their objection about preventing speculation. It echoed the claim by Greenspan that it could not properly identify bubbles. Speculation was something that could only be ascertained once the crash had actually happened, and then it would be too late.

For about eight years, the BoE claimed that it had beaten inflation. It met the target and told the rest of us that everything was under control. House prices, it occasionally acknowledged, were increasing at double digit rates. So too was the money supply, but this didn't matter because the CPI was nailed down. Furthermore, the BoE managed to do this with historically low interest rates. In short, they implicitly told us "sit back, relax and if you feel like it, take out a loan."

However, the truth was that the CPI was declining because of the extraordinary increase in the world supply of cheap manufactured goods, mainly coming out of China and other emerging market economies.

During these years, the CPI should have been negative; a fact that the BoE were happy to ignore. Domestically determined prices were increasing sharply. (If you want proof, just take a look at the price of UK rail tickets or the council tax.) Putting a cap on this hidden inflation would have required higher interest rates, which would have put an end to the housing bubble.

The rest of the story we know. Throughout the decade, Banks were taking on too much risk, households were borrowing silly amounts of money and the housing market was out of control. This sorry mess hit the wall in August 2007. So far, the UK taxpayer has been forced to pump in 90 percent of GDP into the financial sector, just to prevent it from collapsing.

Have policy maker learnt anything from this dreadful experience? It seems not. Later this month, the Treasury will publish a White Paper on financial services. In principle, this offers an opportunity to extend the BoE's target to stabilising asset prices and preventing bubbles.

However, for the New Labour radicals that manage the Treasury, this idea is too extreme. They want to keep things pretty much as they are. The BoE will continue to target the CPI and asset prices can do what they want. In principle there is nothing to prevent a recurrence of the current crisis.

It is very much a case of "keep on doing what you are doing". So, is everyone ready? We have a one way ticket back to Bubbleville.

Why fiscal stimulus packages don't work

Here is further proof why those large fiscal deficits only serve to weaken economic growth.

Since August 2007, the US economy has experienced two fiscal stimulus packages. The first was under Bush in April 2008; the second was under Obama in January 2009. The idea behind both packages was the same. Cut taxes and increase government spending in order to put money in consumer's pockets, who would then go out and buy stuff and sustain economic activity.

However, US consumers have other ideas. Instead of spending, they have decided to save. The US savings rate has jumped to almost 7 percent. Back in the bubble days, US household savings rate had fallen to almost zero.

The jump in savings is even more surprising given that US interest rates are close to zero. US Households must be very keen to save.

Both stimulus packages can be clearly identified in the US savings rate. The first peak is Bush. The recent upswing in savings, which starts in 2009, is due to Obama.

So why are US consumers suddenly saving? Everyone knows that the current deficit is unsustainable and therefore taxes will soon have to increase dramatically. The current increase in household incomes are temporary and they will soon fall when higher taxes kick in. Consumers are trying to stabilize their income over time and building up their assets in anticipation of the future federal clawback.

Economists call this Ricardian equivalence, but that is just a fancy name for a simple idea. Consumers instinctively know that a deficit must be paid back and that fiscal stimulus packages never work.

The irony is that we have known this since the days of David Ricardo, who first explained this principle. He lived during the 19th century. So why are we having to learn this lesson again?

Michael Moore has a new film

I don't agree with his politics, but I do enjoy the movies. I will definitely be going to see this one.

What is going wrong with corporate lending?

Government guarantees, bank recapitalisations and quantitative easing might do the trick for mortgage lending. However, corporate lending is still in the doldrums. There is no big credit expansion here. Gross lending has not increased, while existing credit lines continue to be withdrawn.

Why? Even during the boom, UK Banks didn't like lending long-term to UK firms. It is an aversion that goes back well over a century. Back in the late 19th century, banks preferred to finance trading activities. More recently, personal credit and mortgages have been the preferred option.

The quality of collateral is always a problem with firms. In the event of a default, it is always much easier to sell off a repossessed home rather than a warehouse full of widgets.

This raises a troubling question for the current "boost credit at all costs and inflate the deficit" strategy of New Labour. Lets start with the deficit. Everyone knows it is far too big. We also know that there will be massive expenditure cuts once the election is over next year. This means that in the second half of 2010, the UK will almost certainly hit another recession. Therefore, the Banks are being very prudent avoiding the corporate sector.

Monetary policy is also an incoherent mess. The central bank claims it is trying to prevent deflation, yet inflation has been above target throughout this crisis. It has tried to lower interest rates by printing money. However, financial markets had other ideas. Reflecting higher inflationary expectations, long term rates are beginning to creep up. And despite all the monetary innovations and experiments, credit to the corporate sector is still weak.

A better strategy would be to return to economy to a path that ensures macroeconomic stability. This means cutting the deficit and putting an end to the zero-rate monetary madness of the Bank of England. The corporate sector needs long term stability, not short term fixes that New Labour think will help them during the next election.

Mortgage approvals increase in May

Is the glass half empty or half full.

According to seasonally adjusted data from the British Bankers Association, mortgage approvals reached 31,000; 74 percent up from the November peak. However, approvals are down 50 percent from a typical pre-crash month.

For what it is worth, I think there is a recovery taking place. Moreover, I fear that it will gather pace on the coming months.

Superman money

A superman needs a super-sized salary. Stephan Hester, the CEO of the state-owned bank RBS, is so productive that he can demand a £9.6 million pay package.

Am I jealous? Well, maybe just a bit. However, I have genuine difficulty in understanding how such a preposterous salary could be granted to a public-sector employee.

The villains behind this shameful decision will argue that Mr. Hestor is an exceptionally gifted man and that talent does not come cheap. Besides, much of the payment will take the form of bonuses, which are related to specific targets. If Mr. Hester doesn't produce, he doesn't get paid.

Notwithstanding this superficially plausible argument, Mr. Hester would have almost certainly accepted a salary package half the size. The marginal productivity gain from each additional £1 million added to his salary would have been minimal.

So why do companies hand out such ludicrous packages. It stems from shareholder weakness. Each additional £1 million of salary paid to Mr. Hestor is £1 million less that can be paid out as dividends. Even in the good times, banks paid modest dividends. However, salary growth throughout the boom was phenomenal. Therefore, shareholders have an incentive to hold back these offensive remuneration packages yet are unable to do so.

Today, large corporations including banks are effectively controlled by small groups of management insiders. The control is most striking on executive compensation committees. With each passing pay round, more of the operating surplus of companies has ended up in the pockets of the management rather than shareholders.

But what about RBS -isn't there some kind of political control exercised over this public enterprise? Therein lies the true scandal of this pay package. UK Financial Investments, the body that controls the taxpayer’s 70 per cent stake in RBS, approved this incentive plan.

It is another victory for bankers and another defeat for taxpayers.

A day in the life of Alistair Darling

Poor old Mr Darling; with only months left before he faces the wrath of the electorate, he is certain to earn the title “Britain’s worst Chancellor”. During his short tenure at the Treasury, he has been responsible for the largest fiscal deficit in history, coupled with the deepest financial crisis in a century.

The Chancellor is now stuck between a rock and a hard place. The financial arguments in favour of expenditure retrenchment are overwhelming. Both the Treasury and the Debt Management office have pressed the red button. They have told the chancellor that the current policy framework runs the risk of an outright fiscal crisis.

However, Brown's electoral strategy has painted the Chancellor into a corner. The Prime Minister will not countenance any public expenditure cuts until after the election.

Meanwhile, the Bank of England's wild experimentation with quantitative easing has only added to the Chancellor's problems. The BoE is printing money, offering mortgage guarantees and generally building up a huge repository of problems for the future.

Darling is in a deep dark hole and there is no way he can dig himself out.

The Treasury reality check

Every day, Darling has to face his senior Treasury officials, who arrive in his office with ever more alarming numbers about the deterioration in public finances. This year, the deficit could be as high as ₤200 billion.

The numbers will be packaged in memos pleading for expenditure restraint. However, Darling knows his capacity to rein in spending departments is close to zero. The best he can do is to ensure that he can come up with the cash to cover the deficit.

The UK debt blow-out

The message from UK's debt management office is also dire. It has warned Darling about the increasing difficulties in meeting the mounting financing demands from the government. With each passing week, its capacity to sell government paper is being tested to the limit. Although it has a few remaining tricks in its box, such as syndicated commercial bank debt issuance, there remains a serious doubt whether the UK government securities market can absorb such a huge increase in supply.

An increase in government bond yields offers the only hope for satisfying the financing demands of the government. Nevertheless, higher yields undermine the government's stated aim of increasing credit flows to the private sector, especially the housing market.

The Bank of England - Whatever happened to interest rate management?

The Bank of England has deeply disappointed Mr Darling. The monetary policy committee had promised that quantitative easing would bring interest rates down. Last autumn, the committee had, for all practical purposes, lost control of interest rates when it began to cut its policy rate below the rate of inflation. All other interest rates in the economy obdurately refused to decline, most notably mortgage and corporate lending rates.

The MPC thought that wall of money would do the trick, allowing it to re-establish control over liquidity conditions. Instead, quantitative easing has provoked an increasing fear of rising inflation that has pushed up long-term interest rates. In short, the BoE and its wacky ideas about monetary policy only have created more problems for Darling. Despite the unambiguous evidence that quantitative easing has failed, the BoE are likely to persistent in this yield-raising foolishness.

The chief won't listen

Darling understands that the sensible thing would be to cut back on public expenditures. At this stage, the magnitude of cuts wouldn't have to be too dramatic. All he needs is a sustainable and convincing deficit reduction plan, with a modest expression of commitment in this fiscal year. Once markets understand that this year's huge deficit is a temporary event, the government will be able to sell debt at lower yields.

Although the Chancellor has undoubtedly presented the case for fiscal prudence, Mr Brown has countered with his electoral strategy. The Prime Minister wants to paint the Conservatives as the party of draconian public expenditure cuts. This theme would look rather weak if Brown were to start the expenditure retrenchment before the election. Brown wants New Labour to be the party of the public sector, and Darling's desire to establish a modicum of macroeconomic stability conflicts with the strategy.

A 12 percent of GDP deficit is a post election problem.

This “ignore the deficit" game plan runs the risk of a catastrophic fiscal crisis, where investors are unwilling to provide the financing to cover the deficit. However, for the Prime Minister, it is a risk worth taking. If the crisis happens, the election is lost anyway.

If the crisis can be avoided, and some modest economic growth could be restored, coupled with stabilising house prices, then the chances of a new Labour victory increase. If Labour wins, it has five years to clean up the mess. If it loses, it is someone else's problem.