Factories In The Doldrums

31st July 09 - Factories in the doldrums

Whatever slightly brighter news there may be around with retail sales and the stock market both picking up, factory orders in the UK as a whole not only remain low but things are getting worse. The CBI’s quarterly industrial trends survey covering a period from July 09 revealed that orders are at the lowest level since January 1992.

The survey asks businesses to assess whether they consider their order book to be below normal. Taken forward to September 09, 59% of respondents confirmed the below normal status and this compared to 57% at the August 09 point in time. Specifically on the export side, the trend was worse in that the September % was -45 compared to an August figure of -34%. The export position is particularly bad given that the weak pound should be boosting exports whereas in fact the collapse in demand from overseas markets has consistently outweighed this advantage.

The weighted percentage of firms who consider themselves to be working below capacity stood at 70 for the month of July 09 and is forecast to rise to 76% in August. The one shaft of light related to output and sentiment. Output over the past three months improved to -31% from -53% and sentiment on output expectation improved to -14% from -32%. But, as was pointed out by Jonathan Loynes, chief European economist at Capital Economics, "The improvement in sentiment appears so far largely to reflect firms’ hopes rather than any firm signs of an improvement in actual demand for their products. The outlook for the industrial sector remains highly uncertain at best."

Meantime my sleeping beauty of a moribund furniture factory in Nottingham has been dealt another blow. The beautiful magnanimous big bank (RBS) has withdrawn the overdraft facility. This action seems perfectly timed to ensure that the two big orders we are on the cusp of winning cannot be funded. Of course how is the long-standing bank manager to know that in this industry raw materials have to be paid for about two months before the customer pays us?

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The Two Big Mistakes

30th July 09 - The two big mistakes

You could say that hindsight is cheap and easy. A bit like the critic who can not create himself. You could say that things would be that much worse had it not happened and to a limited degree you could be right. Nevertheless, in my opinion and on both sides of the Atlantic two big mistakes were made in what was a hasty attempt to get credit moving again.

The first was to pump money almost exclusively into the banks because they were too big to fail (global in life and national in death as the sound bite from the Governor of the Bank of England put it). Savers funds should have been guaranteed in their entirety but that is all. The banks should have failed and fallen wholesale into state hands. Top management is cleared out, past practices cleaned up and the big bank is re-packaged into ten smaller banks and re-privatised.

The money that went into the bank black hole should have gone somewhere else. It should not have reduced the liability side of the sovereign balance sheet but have added to the asset side. It would occur by investing in people as the best asset of any nation and secondly in projects that can be activated immediately. For the best people affect in the UK, National Insurance contributions by employers should have been abolished (there aint any anyway once the jobs go) and 5% of wages credited back to the employer by the state. All employers can then afford to hold on to people longer even if on short-time. Such people have some spending power and are not on benefits. Instant projects include repairing the nation’s infrastructure and forget the capacity increase schemes, the UK is not China. Time to repair the crumbling roads and railways, catch the nation’s breath by quality improvement.

The second big error was to reduce taxation aimed at increased consumer spending. In the UK by VAT reduction, in the US by federal tax easing. It will not work, it did not work. If you feel under threat, your job, your income, your standard of living, you will not spend, you will save. You ran up the debts, now try some reparation. All the statistics show this is precisely what happened.

As it is, the mess drags on as tomorrow’s piece will show and by widening the spreads and increasing the commissions and fees, the big banks are rolling it in.

The UK PM is bankrupt and Obama is feeling the heat.

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QE Programme Not Yet Working

29th July 09 - QE programme not yet working

The credit crunch remains a key issue for businesses throughout the UK. This is despite signs of improvement in the markets and selective economic statistics.

The Bank of England’s Trends in Lending report reveals that the amount of cash available to UK companies dropped further into negative territory due mainly to overseas lenders continuing to withdraw funds from the UK. The annualised growth rate of lending to UK businesses fell from -3.9% in April 09 to -5.4% in May. The report says that "spreads and fees are reported to have risen in recent months, which the UK lenders have attributed to higher longer-term funding costs and credit risk."

The B of E had hoped that via its quantitative easing programme it could push money growth higher and consequently increase overall economic growth. So far this is not happening. Indeed other statistics from the central bank show that the level of money contracted by 0.2% month-on-month in June 09 which was the biggest drop in four years.

This might all seem very dry but, excusing the pun, it is the flow of money in the system that primes the pump and promotes credit. The fact is, it is not yet increasing and simple arithmetic shows that as £125bn has been injected through the direct purchase of gilts and bonds, more than this vast sum must have been extracted. Well, I didn’t take it and you didn’t take it, but someone must have. It must be those foreigners and yet aren’t they the same people needed to keep buying at our gilt auctions to fund our debt?

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The Third (Tory) Way

28th July 09 - The third (tory) way

Over the past few diary entries we have covered the emerging proposals for ensuring that a banking crisis to rival the present one will not arise in the future. In particular the Government sponsored report by Sir David Walker and the mooted solutions from the European Union. In the former case the answer is to strengthen the existing tripartite arrangement involving the Treasury, Bank of England and the FSA with greater regulation and in the latter case the establishment of three new major European bodies to superintend all sovereign rules.

Now comes the third way. So far this diary as commented on actual events as they unfolded and avoided matters hypothetical or conjectural. However, so likely is it that the next UK administration will be a Conservative Party one that new Tory proposals for the financial services industry must get an airing. Not only that, these ideas are so different from the two conflicting sets mentioned above that they need setting out for philosophical reasons.

In a nutshell, the Conservative Party proposal is to pass to the Bank of England the power to control the balance sheet of all Britain’s major banks and finance houses. It would also regulate the whole of the broader financial system. Added to the B of E’s existing power to control interest rates, the new set up would in all practical respects mirror the US’s Federal Reserve. In effect the Governor would be the head banker and chief economist all in one.

A Conservative administration would:-

• Scrap the tripartite system and abolish the FSA

• Create a new Financial Policy Committee to maintain financial stability (sister to the existing Monetary Policy Committee)

• Set up within the Bank a Financial Regulation Division to micro-manage individual banks, building societies and insurance companies

• Appoint a Treasury minister to fight for British interests in Europe

• Create a new Consumer Protection Agency

It all sounds much more likely to succeed in that one body is accountable. A bit like the old Railway companies used to be. Will it make the trains run on time with seats for passengers and be responsive to complaints? In theory it might: trouble is past experience shows that all that happens is that civil servants get new names and are shuffled to the new set-up. Can mind-sets be changed.

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Part-Time Britain

27th July 09 - Part-time Britain

Official statistics show that there are now 2.38 million people unemployed in the UK. Digging a bit deeper we find that this headline figure does not indicate the full extent to which the recession is hitting overall employment levels. There are 21.47 million people in full time jobs according to the Office for National Statistics which represents a drop of 595,000 on one year earlier. However, at 7.53 million, the number of part-timers has risen by 51,000. More poignantly, 927,000 of those working less than a full week do so because they cannot find a full time job and this figure is 255,000 higher than a year before.

That 26% of all work in Britain is done on a part time basis highlights a significant shift in attitude and flexibility on the part of both employers and employees compared with previous recessions. Amongst major employers offering their staff reduced hours or extended holidays are:-

• BT

• BA

• KPMG

• Norton Rose

• Ford

• Honda

• JCB

The head of policy at the Institute of Directors, Corin Taylor, said "This recession has been marked by employers being very flexible. They are very keen to hold onto good people, even if that means freezing or cutting pay. And that has to be a good thing. But it does suggest that we are in a far more severe downturn than the headline jobless figures suggest."

Down in the trenches it has to be said that over 80% of people employed in the UK are not employees (full or part time) of the big businesses but rather the small to medium size enterprises. And these businesses can only carry any employee for so long when orders dry up and the requirement to pay full notice periods as well as statutory redundancy makes things worse. Furthermore, the hidden tax of employer NI is a major factor in costing the retention of staff however few hours a week they agree to work.

We need flexibility on the taxation side too, that is levying it not just delaying payment of it.

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It’s Called Management, Stupid.

24th July 09 - It’s called management, stupid

Two days ago I poked fun at some content of a White Paper that will eventually emerge from a Government-sponsored report by Sir David Walker into corporate governance of financial firms. Specifically the recommendation to shine a light on pay levels for senior managers and for these executives to be appropriately qualified.

The report carries 39 separate recommendations and of which 12 are dedicated to pay. Naturally it is the key components of these 12 that have hit the headlines: but that is to miss the point. Like in John Buchan’s classic romp, the 39 steps are only a means to an end, an end with Scottish connection. The main aim of the report is to change the culture of governance. It is not about rules. And for governance read "management".

Sir David summed up his aspiration as follows, "making the boardroom a less cosy , comfortable place." A bank’s directors should be more accountable and in particular should be subjected to annual election. The managerial accountability was spelt out as follows, "The sequence should be that the executives make a proposal to the whole board. The board must then rigorously challenge the proposal before a decision is made on whether to go ahead, not go ahead or modify. Only then should an executive be empowered to go forward."

What we are dealing with here is structured democracy. A process in which accountable managers dare to say their piece and have experience to stand on in wielding the necessary authority to that piece. It may seem blindingly obvious to those outside the top club, but I can assure you outsiders that a dominant executive is a dominant executive. What is being asked for is good, sound, competent management.

The proof of the pudding, as ever, is in the eating. How did Sir Fred Goodwin execute his strategy without proper challenge from the board of RBS? How did the then Lloyds/TSB manage to purchase HBOS without the usual degree of due diligence?

These items of principle are infinitely more important than the 12 recommendations on pay, but of course we are dealing with human beings after all.

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Exit From QE?

23rd July 09 - Exit from QE?

The Monetary Policy Committee of the Bank of England is close to reaching its target of £125bn of quantitative easing. The ceiling endorsed by the UK Treasury is £150bn and it was widely expected that at the July meeting, the final tranche of £25bn would be approved. But not so. It is believed that senior Bank policy makers have concluded that whilst deflation was a significant threat (hence the QE programme in the first place), the combined weight of monetary stimulus through interest rate cuts, QE itself and sterling’s depreciation against major currencies, will serve to prevent a deflation trap. Indeed, official figures show that the annual rate of the consumer price index only dropped from 2.2% in May 09 to 1.8% in June 09. This is a very tardy decline and caused by the reduced cost of food, drinks and transport. Mainly to blame for the holding up of the inflation rate has been the increase in the price of oil.

The decision not to carry on with buying Government debt with newly created money caused one of the biggest leaps in government bond yields since the programme began in March 09. The benchmark 10-year gilt yield leapt by almost a fifth of a percentage point as traders abandoned UK government debt fearing that the Bank may abandon its purchase of them altogether. The yield was at 3.8% by the end of the day and the pound rose by almost one and a half cents against the dollar to close at $1.6235.

If the programme of QE is coming, or has come, to an end, is that a good or bad thing for the UK economy? In my humble view, it is a good thing since it should not have started in the first place.

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An Alternative Bank

22nd July 09 - An alternative bank

In the same week that the UK Government produced a White Paper promising to make banking companies disclose the remuneration of non-directors (bearing in mind the pay of the top tier is already shown in the annual report and accounts) and also expressing the pious hope that bankers will have banking qualifications (would you entrust the preparation of your accounts to a non-accountant?) ".. long pause for effect "", a welcome alternative to the conventional (or unconventional) bank has emerged.

M&G, via its asset management arm Prudential, has raised £1bn for a new fund that will provide loans to UK companies finding themselves at the wrong end of bank lending. The objective, as boosted by a hoped for further £1bn, is to lend to "stable solvent companies" with financing needs but who have struggled to get loans from the high street banks. The investment vehicle will be called the UK Companies Financing Fund and will facilitate pension funds and the like to lend directly to medium-sized businesses in the form of a bond with a minimum term of five years.

Investors in the new fund will receive an "attractive rate of interest" which will come with a premium compared to loans provided by banks. Such investors already include Local Authority pension schemes and private sector schemes. Prudential itself has committed £500m from its life fund. Bernard Abrahamsen, director of fixed income at M&G, said the fund could also be used to refinance existing loan facilities but would not provide a bailout for struggling businesses. "There is very definite need for such funds like this and we are in discussions with several borrowers at the moment."

If this works, what a welcome breath of fresh air it might prove to be. Just imagine popping down to your local man from the Pru for that mid-term business development loan. You never know, he just might be paid a proper salary for a proper day’s work and if you are really lucky he might even be qualified to do his job.

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How Is UKFI Doing?

21st July 09 - How is UKFI doing?

Regular subscribers to this diary will recall that a company called UKFI was set up by the UK Treasury in November 2008 to take charge of the taxpayers’ 70% stake in RBS and 43% in the new Lloyds Banking Group itself a product of merging the old Lloyds/TSB and HBOS. The shares purchased by the UK Government in the autumn of 2008 cost a combined sum of £34.5bn. It has not so far proved to be a fabulous investment. At 30th June 09, these holdings had a combined market value of £23.6bn, a loss of £10.9bn or 31.5%.

With such a book loss and bearing in mind that the value of toxic assets to be covered by the Government’s asset protection scheme is £580bn and a grabbing headline investment in these two banks per UK household of £3,000, it was with no little interest that the world awaited eagerly the first strategic document from UKFI’s chief executive John Kingman.

In the event it was a non-event. The strategy is of extreme caution in that the Government will hold their stake for "several years". "This cannot be a short-term game" said Mr Kingman. You are telling me! Anyone who has owned a personal portfolio of shares showing a cumulative loss of over 30% in seven months knows he either takes a nasty knock or is in for the long term. Furthermore, it is no "game". This is serious work-a-day stuff affecting the next generation and thereafter.

The question arises, how will the Government off-load its shares. Apparently the thinking is a piecemeal disposal over years and made up of at least three methods, a public share offer, issuing exchangeable bonds and private placements.

Someone, somewhere must have faith in the workings of UKFI because notwithstanding its appalling investment results thus far, it is due to take over the mortgage books soon of Northern Rock and Bradford and Bingley. Also, the Government is set to inject more funds into RBS soon to take the total investment into the combined RBS and Lloyds to about £60bn.

Does anyone out there know what the FI bit stands for?

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Nature or Europe Fills A Vacuum

20th July 09 - Nature or Europe fills a vacuum

The diary entries dated 16th & 17th July sent-up and then criticised respectively the UK Government’s Financial White Paper intended to rebuild the financial system. I now see that Keith Boyfield, the co-author of a report by the Adam Smith Institute and the London Business School and who chairs the Regulatory Evaluation Group has said that a raft of proposals coming from Brussels amount to an extremely serious assault on the City of London. "When you look at this you wonder whether Alistair Darling’s (the current chancellor) White Paper is a pointless exercise." Quite.

The point that the report is making is that the EU’s own plan for a new machinery of financial regulation is an opportunistic attempt to extend the powers of Europe and is primarily based on unsubstantiated claims. One could perhaps say it is rushing to fill a vacuum so hated by nature and that would not exist had national governments taken a firmer grip and much sooner.

The report goes on "The proposals seem opportunistic, using the financial crisis to provide an opening for long-held political objectives." It accuses Brussels of trying to transform the system "while it is too weak to object". "Since financial crises of this scale come along only every 60 years, there is no economic reason for this haste."

We can contrast the ideas set out in the UK White Paper (see the diary entry of 17th July) with what Europe is proposing :-

• A European Central Banking Authority will be set up in London

• A European Insurance & Pensions Authority in Frankfurt

• A European Securities Authority in Paris

each of which will have permanent staff and binding powers.

Mind you, the UK’s FSA will be left with "day-to-day" matters and the UK’s prime minister has said that the UK’s "fiscal sovereignty" will be preserved. But with a vacuum already filled ..

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White Paper Or Whitewash?

17th July 09 - White Paper or whitewash?

The UK government has published its Financial White Paper on overhauling the entire financial system so as to avoid a repeat of the current credit crisis. The paper has been in the boiling pot for the past nineteen months so the final broth ought to be tasty enough. Whether it is or not is highly questionable. There are four key recommendations :-

• The FSA will have extended powers. It will become responsible for new requirements for higher levels of capital and lower leverage ratios. In other words a bank must have more reserves to fall back on and must lend less in relation to security held. Of course, two major UK banks are Government owned and the rest are rapidly repairing their balance sheets in preference to taking any more risks. The extended regulatory powers therefore seem superfluous

• An overarching "super-regulator" will be created called the Council for Financial Stability. It will bring together on a regular basis and formally the three key players already at work in the existing system namely the Chancellor, the chairman of the FSA and the Governor of the Bank of England to decide whether to impose harsher restrictions on banks. Wow, what an innovation. What do they do when they meet now?

• The FSA will have the power to veto pay packages and penalise companies for inappropriate deals and will produce an annual report. The City boys must be trembling with that one

• Finally, wait for this real stunner, plans will be laid to help consumers and boost financial education. There will be a national money advice line funded by the banks and a strengthened deposit protection scheme. The private sector got there first on advice and on deposits, they should be protected 100% anyway

The brain power behind this White Paper is truly mind-blowing. No more future financial crises - guaranteed.

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While The Tinkers Tinker

16th July 09 - While the tinkers tinker

Tinkers used to visit villages and go from house to house offering to mend pots and pans. They did this because villagers didn’t travel much preferring to keep themselves to themselves and because money was short and it was cheaper to get things repaired than have to buy new.

When a slump occurs it is always preceded by a boom. It is a sort of economic definition. Some people think that as well as trying to repair the damage caused by the slump in economic activity, we should address the manufacturing process of the boom times. That is to say, we should be a bit more like the old-time villagers and in the good years put a bit away for the lean times to come. The Bible had a bit to say on the subject. Joseph, Jacob’s favourite son predicted seven years of feast followed by seven years of famine. But before that, he had been stripped of his coat of many colours.

Of course Joseph has long gone and prophecy is a dead art. Once we start to feast, we keep on feasting, we even borrow bread to afford next week’s meat not to mention wine. What is more, things are so technologically fast now that seven years is almost a generation in cognitive terms so that no-one actually has experienced a year of famine.

Now that the credit crunch is really hurting in every crevice and corner, it is recognised that the big issue has to be faced. How to stop a time of feast becoming a veritable boom, how to make the merry-makers set aside for the rainy day to come. How to make sure that a future generation does not have to assume a financial burden equivalent to a whole year’s GDP (or for the UK about £1.4 trillion of liabilities).

That is what the UK Government’s long awaited and much heralded Financial White Paper was going to address "a road map for rebuilding the financial system." Except there is no rebuilding, no new products to take to market. The tinkers are back in town. Boring details, if you can stand it - tomorrow.

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GM Restructuring Approved

15th July 09 - GM restructuring approved

In the early days of this credit crisis, all three of the big US auto manufacturers were hauled before the Senate and in varying degrees went cap in hand to the authorities for the finance to survive and restructure. For Ford it has largely been a case of self-help and retrenchment, for Chrysler they found an Italian way but the one that caught the imagination most has been GM. To some degree (writing from a UK perspective) this is because of the long-standing and deeply ingrained presence of GM in Europe through its Opel and Vauxhall labels. And, it has to be said, these two marques have benefited as much as any from the various European scrapping initiatives.

Like phoenix, a new GM is emerging, not so much from ashes as from Chapter 11 bankruptcy. This is because a judge has approved the sale of its strongest assets to a newly formed company. The new GM will emerge with the following owners:-

• US Government 60.8%

• US Unions 17.5%

• Canadian authorities 11.7%

• Old GM 10.0%

and have the Chevrolet, Cadillac, Buick and GMC brands plus a minority of the old GM Europe (the new ownership of GM Europe is still not decided but see an earlier diary entry on how things are evolving).

Ever since my studying days, I have been impressed by the obiter dictum of judges on landmark cases and the one in this Chapter 11 case is no exception. In his ruling, Judge Robert Gerber wrote:- "Bankruptcy courts have the power to authorise sales of assets at a time when there is still value to preserve - to prevent the death of the patient on the operating table. As nobody can seriously dispute, the only alternative to an immediate sale is liquidation - a disastrous result for GM’s creditors, its employees, the suppliers who depend on GM for their own existence, and the communities in which GM operates."

One could hardly put it better.

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Turning to Russia

14th July 09 - Turning to Russia...

Clearly Ambrose Evans-Pritchard of the Daily Telegraph has also been studying the latest Fitch Ratings report on banking. Yesterday I described the rampaging Chinese banks in relation to a protectionist macro-economic policy. Now Ambrose highlights the not dissimilar situation in Russia.

The Fitch report says that Russian banks may need to raise $60bn in new capital if the recession continues and assuming that the price of energy (the prime Russian export) falls back again. The rating agency thinks that 10% of all bank loans in Russia are already bad and extrapolates in its pessimistic scenario that this figure could reach 40%. James Watson of Fitch said that the loss ratio in Russia was significantly worse than anything so far experienced by the West although it is less than in Kazakhstan, Ukraine and Latvia. One positive note in favour of the Russian debt however is that it is denominated in its own roubles whereas elsewhere in Eastern Europe the populous borrowed in Euros and (worse still) Swiss francs.

The Russian statistics look sickly. The overall economy is expected to contract by about 8.5% this year despite the recent commodity rebound and industrial output is 15% below last year. The budget deficit is rushing north to 6% of GDP although it is estimated that each $1 rise in the price of crude oil adds $10bn to the exchequer.

As regards corrective action, banks are likely to be recapitalised by swapping state debt for preference shares and Russia’s four big banks have raised $24bn in fresh capital. That sounds like a very Western banking approach unlike a statement from the prime minister Vladimir Putin "I am asking the heads of financial institutions to control this situation and not to plan summer holidays until this has been dealt with as it should."

Can’t see our PM stopping the annual break at Butlins somehow.

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China’s protectionism

13th July 09 - China’s protectionism

For a country that lives off global trade and runs a surplus of nearly 10% of its GDP, to consciously protect its own marketplace is to run a major risk. It could in fact be compared to the tariff barriers set up by the US in the 1930’s and we all know what that led to. The dichotomy is of huge proportion in that twenty million jobless are returning to its rural hinterland but there is no welfare provision to give these people spending power to first of all exist and secondly to buy its own goods. Where spending power does exist internally it is predicated to a "buy China" decree. And it is working. Chinese imports are down 20% from a year ago. So what exactly is going on in the middle kingdom?

Some say that China’s banks are out of control. $1,000bn of new lending has been issued since December 08. Is much going towards helping the world economy? Aside from internal infrastructure projects, it is feared that money is finding its way onto the Shanghai’s stock market (the composite index is up 70% since November 08) or propping up ailing builders. Fitch Ratings says in its latest report "With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary. Further losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear." Some observers think that if correctly counted, China’s public debt might be as high as 50% to 70% of its GDP.

China has a self-set growth target of 8% and has given its banks an implicit guarantee for what Fitch calls a "massive lending spree." Exposure to corporate debt is rising at a 30% rate while profits contract by 35%. Current exports have fallen 26%. Over half the new debt is short-term so that there is a real roll-over risk.

Pumping money into a protectionist economy that has little provision for welfare payments and that is reliant for its growth on its export trade is a heady brew. One for sober reflection by an unsympathetic West of debtor nations.

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Back To The 1930’s, It’s Official

10th July 09 - Back to the 1930’s, it’s official

According to statistics complied by the economic historian Angus Maddison, the contraction in the UK’s GDP was the worst since 1931, that means worse than any year during the Second World War and the demobilisation that followed. It is official since the Office for National Statistics (ONC) has pronounced a drop of 4.9% in the year to the first quarter of 2009. The contraction in the first quarter of 2009 alone was 2.4%. That was the biggest one-quarter fall in 35 years. It does not take an Einstein-like brain to extrapolate a fall of 10% for the whole of 2009 (these are my words but those of other people are listed below).

Michael Saunders, chief UK economist at Citigroup "Clearly this is the worst peace- time recession since the 1930’s. The worst contraction then was a year of around -5%, this year will not be hugely different." (Was "hugely" a pun?).

Simon Hayes of Barclays Capital "It reinforces the message that the recent signs of green shoots reflect a rebound from an extraordinary sharp fall in activity earlier in the year. We continue to be cautious about seeing them as material news about the medium-term growth outlook, which is likely to be hamstrung by tight credit conditions and the need for fiscal consolidation."

These are the worry beads :-

• The fall in GDP was significantly greater than had been calculated previously

• The recession started in the second quarter of 2008, a quarter before previously thought

• There was actually a deeper cut into construction and services activity than was calculated just a few months ago

• Looking at the UK from elsewhere, the IMF’s latest data showed that international investors’ enthusiasm for Britain has dimmed further

• There has been a third consecutive decline in the proportion of sterling held by central banks and other institutions (IMF)

How is it for you? Some remarkable things happened in the 1930’s.

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Neets Must

9th July 09 - Neets must

If I were writing a crossword clue (which I do), the sentence would probably start something like "Thinking initially of …." and would go on, "Those not in education, employment or training", so producing Neets. According to The Local Government Association (LGA), the number of 16 to 24 year old Neets is going to be at its highest since records began. Many young people could be "stuck in a rut" for years.

An article based on the LGA report by Graeme Paton, the Education Editor of the Daily Telegraph, highlights that teenagers and young adults from white backgrounds are about 20% more likely to be out of work or training than those from black or Asian backgrounds. Women are suffering more than men. The principal causal factors according to LGA are family breakdown and a history of unemployment amongst parents. It wants earlier intervention to target children aged under 11. A further recommendation in the report is that councils are given more power to run their own training courses and funded by reductions in the jobseekers’ allowance.

A piece of related research found that 60,000 school leavers will fail to get into university this year due to an unprecedented rise in demand for degree courses. Figures for the first quarter of 2009 show that 935,000 people aged 16 to 24 were classed as Neet a rise from 810,000 the year before. The LGA report which was co-produced by the Centre for Social Justice, states that those aged over 19 are most vulnerable because they are "not at the centre" of government targets, which focus on under- 18’s.

Perhaps there is an element of partisan posturing involved with these bodies but it is very concerning that as many as 1 million youngsters are out of the loop. Not everyone can be higher educated or indeed suited to development but still this particular aspect of the credit crisis is amongst the most painful to hear about.

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Tracking The Four High-Yielding Equities

Tracking the four high-yielding equities

In an article on my website dated 8th December 08, I listed four equities that were deemed safe, being public utilities, and had high yielding returns, to track how the capital element of any investment would stack up as the credit crunch crisis evolved.

My update on 5th February 09 was very encouraging in that the capital gain was 12.2% just in that two month period. The businesses were:-

• National Grid

• Scottish & Southern Energy

• Centrica

• Severn Trent

Over these four companies the equity value as at 7th July 09 is exactly back to the position in December 08. We are dealing with four of the best businesses in the UK.

So much for a stock market recovery. Take the dividends and hold on, it can only get better again. Can’t it?

Prenatal Pension Cost

8th July 09 - Prenatal pension cost

Neil Record, a former Bank of England economist has drafted a study for the British-North American Committee (BNAC) on Britain’s unfunded pension liability. "These commitments are destined to pre-determine the use of monies from taxpayers as yet unborn." As if the future wee ones won’t have enough to worry about in a world disappearing down a fast-moving gadgetry black hole (my quote).

The fact is, apparently, that generous public sector pension promises in the UK are three times as much a drain on the private sector than in North America. The figures are that civil servants and the like in the UK clock up a bill equivalent to 85% of annual GDP (or £1.18 trillion out of £1.4 trillion). The US figure is 28% of the £9.7 trillion GDP and Canada 27% of £950 billion.

Does it really matter? Yes it does. It is a ticking financial time bomb. It is inequitable, partisan and wholly unjustifiable. First that it is present at all, second that it is kept under wraps and thirdly because it is self-serving to those that hold the rule book. There must be an outside chance that this next generation might have the guts to revolt. To make the public sector worker pay a portion (say 50%) of their copper-bottomed after-work income into a scheme to supplement either the state scheme or a new private scheme for common division.

Standard and Poor, the rating agency, has warned that public debt (and we could add to that the off-balance sheet public/private financing commitments) could quadruple from current levels to twice the national economic output by 2050 unless public sector pensions are brought under control. The BNAC added that "in all three countries, governments are recording the annual cost at less than half the cost at market rates."

Even public sector workers have children, don’t they?

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Another Rocky Road

7th July 09 - Another rocky road

In yesterday’s diary entry, the history of Northern Rock was regurgitated. Now, in a document submitted to the European Commission, the UK Government has warned that it may have to inject more than the planned £3bn of capital "in a stress scenario." It goes on "This structure will assist a return of BankCo to the private sector at an earlier date than would otherwise be the case." So what is BankCo?

It seems that there has evolved a plan to restructure the old mutual building society (now nationalised) into a separate bank with a capital requirement of 8% and a "regulated mortgage lender" which requires 1% of capital reserves. BankCo will be the baby. It will consist of :-

• £20bn of retail deposits

• £10bn of mortgages

• £5bn of the state’s £10bn loan and

• £5bn cash,

some baby you might say.

But the vast majority of Northern Rock’s assets will go into a new business to be known as "AssetCo". This animal will hold about £80bn of assets and have around £1bn of capital.

The desire is for the EU to give the ideas state aid approval and if granted, BankCo will increase its lending to about £24bn by the end of 2010 and absorb about £2bn of capital. Northern Rock aims to raise £1bn by buying back its subordinated debt at a reduced price although with a third of the book in negative equity AssetCo could require further support of £xbn to cover a capital shortfall in 2010 - 2011. Furthermore, AssetCo will receive "a working capital facility of up to £xbn ... in addition."

"X" of course is an unknown quantity. Oh what a tangled web we weave.

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Bring On The Mid-Tier Champion

6th July 09 - Bring on the mid-tier champion

Pretty much as a direct result of the credit crunch crisis, the financing of the remaining mutual building societies has become a mess. In the UK, Northern Rock started the rot by going way beyond traditional means of using "short" savers’ deposits to fund "long" mortgage lending. They went to the wholesale market and bought those funny bundled instruments that this diary first tried to explain over eight months ago. It was when these investments would not roll-over that the financing of the society started to implode.

The scale of the re-financing problem can be demonstrated by the fact that I had a one-year bond with a mutual society that has just expired and paid 7.07% (what the odd .07% was all about I never knew). In a few days there is a second bond that paid 6.75% and soon a third paying 6.9%. This time last year building societies had to bring in short cash just to plug holes in the balance sheet, it did not help with what they were set up to do namely lend to first-time buyers and upwards in the ladder.

By making lending terms tougher, the financing position has improved for the mutuals but by the time rates had dropped the actual housing market had collapsed so that the punters were absent. It has to be said that things have improved a bit and savers can get up to 4.5% on a two-year bond and mutuals are starting to insist again on fixed lending rates. Nevertheless, for some societies the balance sheet was so weakened as to demand redress. That is where a mid-tier champion comes in. Observers believe that a process of consolidation will result in such a champion having funding of around £35bn. Actually this will only cement a process witnessed over the past year where, for example, the Derbyshire was gobbled by the Nationwide and the Catholic by Chelsea.

Now here is the rub for the independent status of mutuals. A new financial instrument has emerged called a PPDS (profit-participating deferred share). It has already been thrust upon the West Bromwich Building Society and Newcastle BS could be next and possibly Chelsea (see a previous entry). What PPDS’s do is improve the tier 1 capital ratio by converting tier 2 debt, that is, switching debt to equity. The results of current stress testing is likely to accelerate the process.

How the well-paid directors of independent mutuals must regret deviating from the path of the righteous.

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We Can Sell Our Debt, Honest..

3rd July 09 - We can sell our debt, honest

Was he talking it up with tongue in cheek or does he really believe it? Robert Stheeman, the head of the Debt Management Office, has just told a conference in London that the UK has no risk whatsoever of facing a "buyers strike" due to investors walking away from its debt issuance. Mr Stheeman’s words to the beautifully titled Euromoney Global Borrowers and Investors Forum are worth repeating. "This notion of a buyers’ strike is something very peculiar to the UK because some people have memories of the 1970’s." (sic) - my embroidery - "This flies in the face of the facts. Government borrowing markets are the most liquid and efficient markets that you will find anywhere. If markets have trouble absorbing issuances then prices will fall and yields will rise. What we won’t see is a buyers’ strike."

Referring to the seeming dichotomy (referred to earlier in this diary) of the debt selling going on concurrently with the Bank of England’s printing of money, Mr Stheeman said his office was "colour blind" to that action and was carrying on as normal. Indeed, the DMO has already issued a quarter of the debt it planned for this year. He had yet to detect any worrying effects from the Standard and Poor’s negative outlook rating for the UK and added, "When the news came out it was an hour and a half before our biggest auction ever. As it happened we had more bids in that auction than we had ever had before."

That is all well and good but it does not alter the fact that :-

• The debt to be sold this year is £220 billion

• The UK deficit is soaring towards 13% of GDP

• Public spending has to be cut or taxes raised

• The European Commission has lumped Britain alongside Ireland and Latvia (see an earlier diary entry) in the category of "deteriorations of public finances"

• Colour blindness is still a form of blindness

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2nd July 09 - Hedge funds on edge

Hedge funds, 85% of which operate out of London (mainly in Mayfair), were criticised heavily following the breaking of the credit crisis and not least for allegedly selling banks short. When the practice was banned for a period, few could discern that it had made any difference to share prices. Now the industry is under attack from Europe but by its very nature it was unlikely to be a passive party.

The EU Alternative Investment Directive, issued last month, has been attacked by the funds collectively claiming that part of the directive - including restrictions on debt and proposals that only European domiciled firms would be able to market to EU investors - would be unworkable. The UK’s multi-billion pound hedge fund community has issued its first broadside saying it might move to New York or Geneva unless the proposals are watered down. Stuart Fraser of the City of London Corporation said that the European Council was absolutely right to decide more time was needed to discuss the proposed legislation adding "Europe does not like private equity or hedge funds and seems hell bent on driving these industries out of Europe".

The UK hedge fund industry is being co-ordinated by its trade body the Alternative Management Association (AIMA) and a number of prominent hedge funds have set up a steering committee. Lansdowne, Man Group and Marshall Wace are part of this committee. Unlike the venom directed at the approach from Europe, AIMA has welcomed a report from the International Organization of Securities Commissions which proposes new global regulations for hedge funds. These include the larger funds reporting information to their national regulators concerned with systemic risk.

One has empathy with edgy hedge funds. It is certainly a global crisis not an European one by any standard and indeed the leading European players (the UK aside) have been the laggards in dealing with it, as the commentary in this diary over the past eight months has documented.

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