It’s Just Wishful Thinking

30th April 09 - It’s just wishful thinking

What is? The prediction of the UK Chancellor that happing shrunk by 3.5% this year, the UK economy will start growing again "towards the end of the year" and grow by the same 3.5% from 2011 onwards. That is to say, the so-called "V" shaped rebound. Who say so? Well, amongst others, Peter Spencer chief economic adviser to the Ernst & Young item club "It’s impossible to find a period when that sort of recovery has actually come through … If you believe that, you’ll believe anything"

Even if the Chancellor is right, the UK (according to the Treasury’s own figures) will have to borrow £175bn this year and £173bn next year to make up for the shortfall in tax revenues and extra demands on the public purse from increased social welfare spending. At over 12% of GDP, these figures represent the worst years for the pubic finances since the 1940s. Michael Saunders , chief UK economist at Citigroup, said "I shake my head in despair. As the Chancellor faces a terrible fiscal position no one outside the Treasury will belief the forecasts . When I saw the public spending plans I nearly fell off my chair". The extra debt, which again it has to be said most commentators (including myself) belief is optimistic, will push up Britain’s net national debt to almost 80% of GDP.

Just one factor in the failure of revenues to balance the UK books is an increase of 177,000 in unemployment to 2.1 million in the three months to February 09.

Perhaps one solution, or is it retribution, would be for the political opposition in the UK to withdraw from the next election on condition that the present ministers of state agree to have their personal revenue and capital assets, including pension rights, linked directly to the actual % rise in GDP and the actual decline in the ratio of debt to that GDP during the next term of office.

Getting (some of) Your Money Back

29th April 09 - Getting (some of) your money back

A UK Treasury-sponsored efficiency savings report has just been published. The premise is to find funds to offset some of the £billions spent in, inter alia, bailing out the banks following the credit crunch crisis. Here is a list of proposals :-

• "Vest" the Royal Mail into a private company later this year in the "first step towards private investment"

• Sell off or redevelop before 2012 the QE11 Conference Centre in Westmintser

• Privatise the Dartford Crossing

• Sell the Oil & Pipeline Agency which managers the Ministry of Defence’s oil supplies

• Save an annual £7.2bn from Government back office and IT operations

• Save an annual £4bn from back office functions across the public sector

• Save an annual £3.2bn from reduced IT spending across the public sector.

Here is a quote from the report - "The private sector never stops seeking greater efficiency in the ways it purchases and provides services, and neither should government. There is scope to go further and increase the value for money the public sector achieves from both its activities and from some of its most valuable assets - the insight and energy of its people, as well as its bricks and mortar".

Of note is that these plans for raising funds do not include disposing of council houses, not surprisingly since one of the Government’s expected fillips from the new budget is to promote more social housing as a means of kick-starting the near moribund housing market. One hates to add a touch of cynicism to these excellent proposals but I cannot help recalling the response by a certain MD to one of my reports on the efficiency of his business. It went something along the lines of "Pious hope".

One other piece of good news is that the Government plans to spend £1bn on reviving struggling development sites. The target is to build 240,000 homes a year by 2014. This year the estimate for new houses built is between 60,000 and 100,000. One is trying hard not to reach out for the word pious again.

Gilt Strike?

28th April 09 - Gilt strike?

The headline is that according to analysts at Capital Economics the UK faces a deficit of £200bn for the first time in history and the national debt could reach 100% of GDP. On the back of such gloomy news or due to fear of what the UK Chancellor will deliver in his forthcoming budget (let us remember Ireland), the pound slid 2.66 cents against the dollar wiping out slow gains over the past few weeks.

So what you might ask, such huge numbers are just so mind-blowing as to be indigestible. Well, we recorded the recent failure of an auction to sell more gilt-edged securities (the rock-solid investments being backed by the UK’s whole economy) and the prospect is being raised of further failures. Were this to happen, there might only be two alternative courses of action

• Call on the IMF for funds

• Raise taxes.

On the possibility of the former happening, UK ministers have consistently pooh-poohed the idea (naturally - the UK is not in the same league as Eastern Europe, is it) and secondly the head of the IMF thought during a recent interview that there would be no need to help "such a large economy". We then turn to taxation and can you believe, the talk is of a £30bn (about 2% of GDP) tax rebate. It is a bit like the end of the middle game in chess when everything seemed to be going ok to suddenly realise that your opponent has his knight, bishop, queen and rook all bearing down on your weak pawn - and how did that happen?

Michael Saunders, UK economist at Citigroup, said the prospect of a gilt strike (failed auctions) was no longer unlikely "There is no doubt we are closer to the edge now than we have been in ages, How close are we? That is unknowable - it’s akin to being on a cliff edge in the pitch black. There may be a level of fiscal deficit at which people could lose faith in the Government’s commitment to economic flexibility. The fact that we don’t know how close we are to the edge is part of the difficulty. The IMF warned them, the OECD warned them, the European Commission warned them and the Government dismissed the warnings".

Back at the micro level, we have commented twice in this diary about the Chelsea Building Society. It is now reported that it is negotiating with the Bank of England and the FSA after breaching the terms that allow it to receive funding from the Government’s liquidity scheme. Oh dear.

Suffer Little Children

27th April 09 - Suffer little children

On such a nice sunny late Spring morning, it was heartening to see the young children (children, lady presenter and reporter note, not kids, kids are begot by goats) telling the camera with such confidence about their experiences of the current somewhat harder times. One young boy has had his pocket money withdrawn completely since his daddy lost his job and he had noticed that there was less food in the fridge. A girl of about seven or eight years of age had a best friend who sees less of her mummy now that she (the mother) has to work more hours at weekends and a second young man wondered why with all the "stress" about the Government was spending more money!

It seems that a survey of 1,000 six to twelve year-olds found that one in four had been affected directly by the credit crises or had a friend who had and over 90% knew about this big current event in their life. In many ways and just like the sun coming out after a long and chilly and damp Easter, we should take heart from these little ones who face and indeed are the future. Maybe they will have learned that they came through a period when no extra material junk found its way into the double garage or the playroom and less pocket money was forthcoming. Come through it and found they coped quite well; wondered perhaps why mummy and daddy had felt they needed all that stuff in the first place.

The researcher said that parents were spending more time at home with the children and the family was eating at home together more often. It was not clear to me whether she saw that as a downside or not. It would be nice to think that little brains were starting to think that some things can be managed without and that unemployed daddy could do with cheering up. It would be nice to think that they are learning about economics in a practical way especially as their parents and "teachers" have fallen so woefully short. I felt good about this bright, articulate and confident group of children. I felt pretty bad about their inheritance.

Triumph Of Expectation Over Hope

24th April 09 - Triumph of expectation over hope

The new US President Obama has said that he sees " glimmers of hope" in his economy and the Federal Reserve chairman Ben Bernanke saw "tentative signs" of recovery. That is the hope bit.

The number of US citizens losing their homes rose by 44% last month due to banks pursuing defaulting borrowers after mortgage lenders Fannie Mae and Freddie Mac (remember these two delinquent children?) lifted their temporary bans on foreclosures. 175,199 homes were repossessed in March 09 according to Foreclosures.com and so far this year 370,000 families have lost their homes. Also, as regards the trend, mortgage applications are again falling so that notwithstanding that borrowing costs are at record lows, potential house buyers are keeping their powder dry. The Federal Reserve has a so-called Beige Book which assesses regional economic activity. It said that the US economy continues to weaken and found that the housing market remains "depressed overall"

What is more, on the side of expectation, Mike Duke the chief executive of Wal-Mart said the economy would not "just bounce out and come back" - "there is still a lot of stress" among consumers. Looked at another way, consumer prices are 0.4% cheaper than a year ago. This is the first fall in the annual rate since August 1955.

The moral is, be wary of talk of green shoots. Come to that, of any shoots.

As regards the remedial treatment this side of the pond, the Bank of England has bought gilts worth £3bn as the latest tranche of its QE programme. Because sellers offered £9.42bn worth of gilts, the price paid was below market levels. That is quite a surprise and a shock to those who bought gilts recently believing their price would increase given the reverse auction process. It just goes to show - you never can tell where money is concerned.

Moody’s Bares Its Teeth

23rd April 09 - Moody’s bares its teeth

A few weeks ago this diary made a not too complimentary comment on the published accounts of one of the UK’s "mutuals" namely Chelsea Building Society. Earlier this week examples have been given of how the leading credit rating agencies have been, ostensibly, taking a tougher line than hitherto on their ratings. Coincidentally, these two stories have married. Nine of the UK’s biggest building societies have had their credit ratings cut to near junk status and the two lowest grades of Baa3 were handed out to non other than Chelsea plus West Brom. According to the Moody’s report, the only reason ratings were not cut to below this level (which would be regarded as junk status) was "we believe the likelihood of Government support has increased, underpinning the investment grade debt and deposit ratings of these institutions"

Moody’s went on to say that "earnings levels are naturally constrained by their mutuality model and therefore their ability to increase depleted capital levels is more limited" Well, one could make that conclusion thinking of the future with credit agencies and regulators baring more teeth, but it does not seem to have applied in the past as the balance sheet of Chelsea and the former Northern Rock show clearly. The whole trouble was that such "reserves" came from the wholesale market and pretty doggy some of it was.

It has to be said that the current actions of the rating agencies are not without critics. Adrian Coles, the director general of the Building Society Association believes they have swung from the euphoria of splashing around AAA status to an opposite extreme. Certainly the current stress test of a fall in house prices of between 40% and 60% seems extreme when the leading Nationwide index is down only 18% peak-to-trough. Still it is all very worrying especially given the big flight of cash to "mutuals" after the fun with the erstwhile rock-solid banks.

Samuel Pepys was a very smart chap. He rose from nowhere to just about running the British Admiralty. When the plagues and fires came, he took his barrels of best Portuguese port and buried them it his garden.

Singapore’s Whiz To Fizz

22nd April 09 - Singapore’s whiz to fizz

As commented upon two days ago, if you are stuck with an overvalued currency out of your control, then, being Ireland you are pretty much in the mire (or peat). If you are the world’s reserve currency, then, being the US, you must watch your gilt-edged securities or municipal bonds (see yesterday’s diary entry) get down-graded and hope for the best. There is however a third way. Erstwhile whizzy-star Singapore (start reading at page 171 of Violets) has found it.

The Monetary Authority of Singapore has effectively devalued its own dollar. It can achieve this by lowering the trading band in which it is managed. This currency devaluation amounts to about 2% and was less than many expected given that it has lost nearly 10% against its US cousin over the past year. The key monetary devise had to be triggered because, fundamentally, this small thrusting Island jutting out of the southernmost extent of Malaysia (it is no larger than the Isle of Wight off Hampshire UK) has no natural resources. Its economy has been built on exports and financial expertise from a highly educated population of around 4 million people of very mixed ethic background. The credit crunch whilst seemingly light years from Singapore’s entrepreneurial bustle has decimated its high-value exports.

In the first quarter of 2009, Singapore’s economy shrank 11.5% compared to a year earlier. Compared to the last quarter of 2008, it fell nearly 20%. Non-oil domestic exports fell in the month of March 09 by 17%. Manufacturing, as a sector, fell 29% in the March quarter and despite a stimulus package of £8.6bn. These very large numbers are caused by export markets dominated by Europe and the US and also since Far Eastern rivals (the so-called Tiger economies) have been quick to snipe at their envied rival.

When a ripple hits the shoreline of Changi beach, it has come a long way.

Of Moody Municipals

21st April 09 - Of moody municipals

According to a report by James Quinn the Wall Street correspondent for the Daily Telegraph, Moody’s the leading credit rating agency has warned in an unprecedented guidance note that the entire US local government system is at risk. A negative outlook has been attached to $2.6 trillion’s worth of municipal bonds. A warning from this source is significant because municipal bonds are one of the key ways US local authorities raise both medium and long-term finance. Obviously if there is any doubt that such bonds might default, future issues are likely to be unsold (note the failure of the most recent auction of gilts in the UK)

What has happened is that local tax intakes have fallen due to residents losing jobs and as companies close or report losses. A leading example quoted is the state of California faced with a deficit expected to reach $42bn by next year. In the smaller league, Jefferson County, Alabama has been threatening to default on some of its bond payments for some months past. Eric Hoffman an analyst at Moody’s said that those localities most at risk of a downgrade were where there was heavy reliance on auto manufacture, property and financial services.

This diary recorded yesterday a tough stance taken by another credit rating agency Standard & Poor in relation to the Irish economy. These agencies as a body have been on the receiving end of much criticism in relation to the credit crunch crisis and it could be that we are now witnessing a fight back.

Irish Eyes Not Smiling

20th April 09 - Irish eyes not smiling

The Irish economy ought to be working with extremely low interest rates and new money rolling off the printing press. Exchange rates would have fallen drastically to reflect trade with the sterling and dollar zones. Irish eyes if not still smiling might at least be dry. But this UK/US model that might just be starting to bear fruit in their homeland cannot be implemented because Ireland is part of the Euro club. It cannot operate independently on monetary matters and yet the Government has to act and act fast. Half of all Ireland’s exports go to either the UK or America and so have suffered from the decline in sterling in parallel with the high value euro and domestic shoppers are buying in Ulster.

It is estimated that Ireland’s budget deficit will reach somewhere between 13% and 18% this year. Brian Lenihan, the finance minister, has said that the economy will contract by 8% this year to add to the 7.1% drop in the last quarter of 2008 and that prices will fall by 4%. Standard & Poor, the debt rating agency, has taken away the coveted "AAA" rating from Ireland as a nation after predicting that its public debt will rise to 70% of GDP over the next four years (from 33% in 2008). Household debt stands at 190% of disposable income.

What can Ireland do to pull itself together again? As a debtor nation, the only tool it has is fiscal. That is why there has been an emergency budget notwithstanding that the country is tipping into deflation. Taxes have been raised and expenditure cut (note the absolute opposite of the UK treatment). Here are some of the details:-

• Child benefits and job seekers allowance has been cut

• Road and rail projects are being frozen

• Junior ministers will lose their jobs

• A levy on pensions will be increased to 2%

• A new state agency will soak up 80bn euros of toxic debt from the banks

• Unions have agreed to a pay freeze

• There will be pay cuts for public employees

Another local difficulty is that our old stalking-horse, the pension fund, is kicking at the stable door. Unlike the UK, there is no Pension Protection Fund (PPF) in Ireland and so workers such as those at the failed Waterford Wedgwood might get only about 25% to 30% of their benefits whereas with the PPF they would receive 80% to 90%

The boom years are on hold for the beautiful and green Shamrock Isle.

Go Forth and Quantitatively Ease

17th April 09 -  Go forth and quantitatively ease

As noted a few days ago, the Governor of the Bank of England appeared to suggest that the previously announced programme of quantitative easing may be scaled back. This proclamation was mooted as one cause of the failure of a government bond auction. However, the latest meeting of the Bank’s Monetary Policy Committee voted to continue with the programme and noted that since its previous meeting a total of just over £26bn of asset purchases had been made and that in two months’ time the whole £75bn target would be reached. At the same meeting the bank rate was not changed. This was for the first time since September 08.

Speculation on the causal factors of this apparent volte-face centred on deflationary rather than inflationary statistics and mainly that producer prices increased in March 09 at the slowest annual pace in 20 months. Factory gate inflation was up just 2% on the year. Also, the currency weakness of the pound might, at last, be starting to have an affect in that the goods trade deficit narrowed by half a billion pounds to £7.3bn in February 09 notwithstanding the global downturn.

As a post script to the adventures of Barclays Bank, it has agreed to sell its exchange-traded funds business for £3bn although it is providing £2.1bn of this itself as debt finance. The level of debt provided does adversely impact the core tier 1 capital ratio as also does the book value of the business at £1.5bn. Still, the ratio improves to 7% from 6.7% according to analysts Credit Suisse and the bank expects to remain profitable which, of course, is the best way to improve its capital strength. An interesting aside is that the sale deal comes with a "go shop provision" that allows Barclays to solicit better bids until June 18th this year.

G20 Summit: Of Regulations

16th April 09 - G20 Summit: of regulations

Setting to one side the issue of who wanted what or who won or lost, the April G20 Summit in London is going to be remembered for its agreement to tighten up what can broadly be termed financial regulation on a global scale. This diary entry sets out what was agreed : 

• There will be a new authority called the Financial Stability Board. It will replace the present Financial Stability Forum. Although the new organisation will not have specific controls over financial companies, it will have a "strengthened mandate" to oversee the world’s financial system

• Regulation and oversight will be extended to all "systemically important financial institutions, instruments and markets, including the largest hedge funds"

• Action will be taken against tax havens and other non-cooperative jurisdictions, including the threat of sanctions if necessary. The OECD has published a list of such countries and the most at fault are said to be Cost Rica, Malaysia, the Philippines and Uruguay

• New rules will be imposed on credit rating agencies

• New rules will be imposed over banks’ capital requirements once the (sic) crisis is over

In addition to these new strictures, it was also hinted that there could be new rules to limit and/or specially tax the bonuses handed out to bankers. If this happened it would follow the lead of the US.

All this is fine and dandy but for the cynical it must be further agreed globally that 

• No system has yet been devised that could not be defeated by the determined

• Aspiration is one thing, implementation quite another

• There is no world politic or police

• Free spirit drives capitalism, non-capitalism does not work

G20 Summit: Money Beats Fiscal

15th April 09 -  G20 Summit: money beats fiscal

As a sober reflection on the achievements of the G20 Summit held in London on 2nd April 09, it seems that decisions on money policy outgunned the possibility of agreement on more fiscal stimuli globally. Receiving rather less plaudits than the headline $1.1tr new cash for the International Monetary Fund (IMF) and other agencies was the agreement that the IMF could hand out $250bn in new Special Drawing Rights (SDRs). In effect this is our old friend quantitative easing but on an international scale. In some ways it can be thought of as a central bank overcoming political economic will, a sort of Governor of the Bank of England beating the Treasury in a UK context.

What purpose will the SDR’s serve? There are three known plusses. First, nations on the receiving end will be buffered against balance of payments crises (think of the Eastern European block), secondly it gives some protection against currency attacks by money speculators (think of Russia) and finally it can bolster reserves (think of Iceland or Ireland and some South Med countries), or one could mix and match. A further monetary agreement was for a second international agency namely the World Bank to handle a $250bn trade support package. In terms of practical and short-term help to the weaker brethren, these two measures taken together are the most important outcome of the meeting of the mighty 20 club.

The balance of money making up the headline $1.1tr was the trebling to $750bn of the IMF’s resources available to lend plus an extra $100bn of lending to low-income countries by the multilateral development banks. These measures intended to stabilise the global economy were not, in the event, boosted by fiscal stimuli on a global scale. As documented earlier in this diary, Germany will not sign up to that path and neither will France, both preferring indirect help for those out of work plus tighter regulation of financial services generally.

One hopes that the IMF’s money management department is a bit more on the ball than the forecasting department who, in June 2007, said that "The medium-term prospects for the Icelandic economy remain enviable". Oops! The medium-term lasted about two months.

G20 Polarisation

14th April 09 - G20 polarisation 

Hardly had US President Obama’s converted Boeing 747 touched down on UK tarmac for his participation in the G20 summit than his plain speaking showed how stark was the polarisation between the primarily consumer nations and those that have lived by their exports. The former have attempted to stimulate their economy by fiscal measures whilst the latter have generally stood to one side and concentrated on help for those out of work. This polarisation has angered those that feel they have done their bit for the world and such anger is no longer beneath the surface of buried in diplomatic nicety.

At his first and joint press conference with the UK prime minister, President Obama went straight to the crux of it "If there is going to be new growth it can’t just be the United States as the engine. Everybody is going to have to pick up the pace". " Our goal is simply to make certain that each country, taking into account its differences in economic circumstances and political culture, is doing what is necessary to promote economic growth. The US will do its share but in some ways the world has become accustomed to the United States being a voracious consumer market, the engine that drives a lot of economic growth worldwide.....  the sense that this isn’t a situation where each country is only exporting and never importing, but rather that there’s a balance."

President Obama is a great orator and speaks plain English and he cannot give it to the world plainer than that. Some believe that the US Congress is the most protectionist in half a century. Looking back merely at yesterday’s diaried housing and auto industry statistics, it is not hard to understand why. It has already inserted a "Buy American" clause in the US fiscal stimulus package. It could well be that the economic battle lines have already been drawn. Tragically, for those of us old enough to remember, it is Germany that has emerged as the principal villain. China may have manipulated things a bit with its export subsidies but it has also, along with Japan, primed its economy. Japan premier, Mr Taro Aso said "There are countries that understand the importance of fiscal mobilisation, and there are some other countries that do not, which is why I believe Germany has come up with their views."

For the record the three highest current account accumulated surpluses over the past 12 months are (in $bn) China 401, Germany 224 and Japan 143.

The really hard thing to fathom is what would happen economically if the US really and seriously started to look after its own. Europe, probably excluding the UK, could be in a proper mess and, if only to reduce future defence spending, the US is sidling up to Russia. Worth a second thought.

Latest on US Houses and Cars

13th April 09 - Latest on US houses and cars

During a serious and somewhat rupturous tripartite economic discussion on late-night BBC TV the phrase Case-Shiller index crept out. This index tracks US house prices and currently shows that from their peak, prices have fallen on average by 29% and the trend is actually accelerating downward. In the year to January 09, prices dropped 19% in the 20 largest US cities. It seems that the crisis is spreading from the first affected such as Arizona and Florida into hitherto rock-solid neighbourhoods on the East Coast. There is reported concern that Alt-A (one notch above sub-prime) and Option-ARM or teaser mortgages offered in the final phase of the boom period have still not registered fully.

Although rates on standard 30 year home loans have dropped from 6.5% to 4.93% and leading to much refinancing, the benefits have yet to reach those home owners likely to default or face a distress sale. This is simply because such people cannot refinance due to negative equity. California has 1.9 million borrowers in this position. Here is a list of the biggest house price falls over the past year:-

• Phoenix -34%

• Las Vegas -33%

• San Francisco -31%

(go West young man). One brighter note is that an $8,000 tax credit for first-time buyers may have led to a boost in the sale of fore-closed houses. Not that that will have helped those on the wrong side of the track.

Meantime, the new President has rejected the latest plans to re-finance GM and Chrysler who must, in effect, go back to the drawing board or rather the cutting board. Whilst the latter could fall to Fiat of Italy the former could fall to the courts. GM has a new boss who it seems is not ruling out a bankruptcy filing. There is still no succour for the UK’s Vauxhall brand or Germany’s Opel. The hard-line German Chancellor has said that her government will only help to find an investor and the GM European boss said that GM could take a minority stake in a new European corporate structure. 

All in all, things on the car front do not look any more rosy than in the house garden.

The Rain In Spain

10th April 09 - The rain in Spain

....  falls mainly on the plain, the plain that houses the regional lenders that is

We have talked before about the property development crash in mainland Spain and its off-shore islands. Spain’s central bank has taken direct control of the first savings bank to go under, Caja Castilla. It will inject new liquidity to the tune of 3bn euros and provide a further 9bn euros of loan guarantees. Following the announcement, shares fell on the Madrid bourse and specifically by 7% for Banco Santander the saviour of UK building societies Alliance & Leicester and Bradford & Bingley.

Goldman Sachs, the US investment banker, downgraded a batch of Spanish banks last month and warned that they are likely to "suffer disproportionately" in the next phase of the global credit crisis. It went on to say "With Spain facing a spike in unemployment and a burst real estate bubble, signs of severe credit deterioration abound". It is worth mentioning too that Spanish banks have amassed 332bn euros in exposure in Latin America according to the Bank of International Settlements and this is thought to exceed the total exposure from all American banks. In fact, it is akin to the threat posed to banks in Austria, Italy and Sweden relative to their exposure to the Easter European nations.

Unemployment in Spain is the highest of any European country standing at 14.8% and set to reach 19% next year according to the European Commission. In a heart-wrenching comment that somehow seems to echo what the UK authorities must be feeling about the goings on in the mortgage market here, the Spanish finance minister Pedro Solbes said "What was the state supposed to do? Stop people building houses? We couldn’t do that". He went on to warn that building 800,000 homes a year was not sustainable and that granting mortgages for 40 years was folly but that there were certain things the government could not prohibit (note that some commentators believe that the Bank of Spain is the toughest regulator in the world)

A report by Credit Suisse said that Spanish house prices were still exorbitant at 7.2 times family earnings and that "many families are spending 60% to 70% of their disposable income paying the mortgage". It went on to believe that Spanish banks were playing a dangerous game by offering 100% mortgages to offload properties at discounted prices to get them off their books whilst, in their view, there was a risk that these houses were still "50% overvalued."

As a postscript, our friends at Barclays have decided against taking up the Government’s insurance scheme for toxic assets. The maverick strikes again.

Where Is Dunfermline Anyway?

9th April 09 - Where is Dunfermline anyway?

When I still did the football pools, it was possible to bet on Dunfermline Athletic winning at home. I often wondered where this athletic team actually resided. Now I know, just as the whole world knows, that the more static building society of the same name has lost at home - and heavily at that - but nevertheless has made history. The Dunfermline Building Society has been the first to enter the special resolution regime under the Banking Act that only came into force in February 09. So what triggered the demise of the 11th largest building society in the UK?

In January 09 Jim Willens, a former Nationwide Building Society director was brought in to Dunfermline and discovered it was in deep trouble. Soon after, auditors Deloitte & Touche decided that the potential bad debts were too severe to enable the accounts to be signed off. They contacted the FSA who together with the Treasury and the B of E launched a rescue plan. The white knight turned out to be none other than Nationwide who, incidentally, had already taken over two other societies during this credit crunch crisis namely Cheshire and Derbyshire.

The structure of the rescue has been of the good and the bad (the ugly having left the drama). The good bits are that Nationwide takes over the 34 branches and the HQ, 534 employees, £2.35bn of deposits, £250m of treasury investments and (wait for it) £1bn of prime residential mortgages. No cash changed hands since the payment is the potential losses on the mortgage book. The next part of the deal is both technical and complicated but for the record and in order for the transferred assets and liabilities to be "matched" the Treasury will transfer £1.6bn to Nationwide. 

This transfer will be funded by a charge on the Financial Services Compensation Scheme (FSCS) and the      Treasury itself. They in turn will secure the funds from Dunfermline’s remaining assets which consist of £450m social housing book, £800m of commercial property and ex-Lehman mortgages and finally £500m of other assets. The social housing package has been placed into a "bridge bank" in an attempt to sell it on quickly. The rest of those assets are now with the accountancy firm KPMG in administration. In the final analysis, the FSCS bears the burden of between £1bn and £1.5bn so that this is the bad bit. It is thought that administrators will recover enough to recoup the insurance exposure and there is also £69m of capital in the society.

Whatever happens from this point, the Dunfermline (like the Chelsea as discussed a few days ago) moved far beyond taking deposits to fund its mortgages and has paid the ultimate price, its independence. Furthermore it has left the taxpayer with the clearing up. And what a mess it is.

Gee Whiz (without the Whiz)

8th April 09 - Gee Whiz (without the Whiz)

There was a world summit held in London on April fool’s day. The principal attendees were the leaders and advisors of the World’s 20 most powerful nations, known as G20. London was chosen because the UK government wanted to take the lead in promoting a huge fiscal stimulus via an idea being drummed up by the UK prime minister himself as he flew around the world to get the leaders on-side (it is a bit like preparing for an important board meeting by having a private one-to-one with the key members beforehand). The germ of the idea was for the whole G20 to collectively agree to pump the equivalent of 2% of world GDP, about $2 trillion, into a further round of stimulus.

The contra view of rescuing the economies has been well documented in this diary and here is another quote from German Chancellor Angela Merkel "German economy is very reliant on exports, and this is not something you can change in two years. It is not something we even want to change". A new voice, that of Michael Froman the US deputy national security advisor, had said "Nobody is coming to London to commit to do more right now. No single number is sacrosanct". It seems clear now that if a key plank of a "new deal" couldn’t find support then the best plan was to quietly back-track and get the PR boys busy especially as a leaked draft communiqué assumed the stimulus package was agreed along with a determined effort to "resist protectionism". China, in particular, was unlikely to be on side given that it had just announced another raft of export tax rebates.

What has to be pondered is this. Those nations with surplus reserve economies such as Germany, China, Middle Eastern and certain other Far Eastern counties, have achieved this status due to rampant consumerism and debt building elsewhere and particularly in the US and UK. If that materialistic grab is boosted again and artificially at that, the processes of the past will simply be repeated. That is no way to re-balance. One other thing is that a large group of people are actually better off right now, for example, the 5.8 million public workers in the UK paying less on tracker mortgages and less on fuel. Why should they spend in this febrile climate. Confidence is what is needed and that is hard won by throwing dosh at the problem.

Our Maverick Barclays Is Clean.

7th April 09 - Our maverick Barclays is clean

This diary has long held an affection for Barclays. It always wanted to stay independent of state control and made no bones about it. It went to the Middle East to get money and rode rough shod over its shareholders in the process. Speed and directness over protocol, often the way of the maverick. Its share price has suffered terribly from the doom mongers who assumed it had much to hide and said that sooner or later it would have to go with its begging bowl to the UK Treasury. But now its shares have risen by 25% in a single day. Why? Because, the FSA has given it a clean bill of health. This means that it can luxuriate over a choice of whether to use the state’s asset protection system and if it does, the terms will be more in its favour due to strength than with either RBS or Lloyds due to their weakness.

The technical process undertaken by the FSA was "a detailed stress test to the balance sheet and profit and loss account". A test aimed at establishing that the bank can withstand a recession longer and deeper than in the 1980’s. Another plus is that even if Barclays does go for insurance of its toxic assets, it intends to pay by way of old-fashioned cash and not give away equity. That must be some compensation for its loyal shareholders. One final piece of the re-building jigsaw is that the bank is on the verge of selling its exchange-traded funds business and is expected to pocket £3bn to £3.5bn .

The story of Barclays is that size and convention are not always the best approach. Neither is impetuosity. Barclays chased ABN Amro ahead of RBS but gave up. Actually that is another lesson.

Statistical Downgrade

6th April 09 - Statistical downgrade

The Office of National Statistics has revised downwards to 1.6% the drop in UK GDP for the final quarter of 2008. This may not sound much but in fact represents the biggest quarterly fall since 1980. One big factor was that construction output fell by 4.9% in that final quarter due in large part to businesses cutting back on inventories (the stocks being held). On an annual basis, the economy actually expanded by 0.7% but this was the slowest annual rate for 17 years and compared starkly with a 3% expansion in 2007.

The real question at this stage is whether the downside trend is set to continue. Maybe there is some cause for optimism here in that Spencer Dale the B of E chief economist whilst quoted as saying that the "near-term prospects are bleak" also added that in his opinion the rate of economic contraction would slow down as 2009 progresses leading to "signs of  recovery" by the fourth quarter. He noted that the consumer price index showed that inflation was steadier than expected. In a different slant on the medium-term trend, David Miles of Morgan Stanley and who is due to join the Monetary Policy Committee in June this year, said that a combination of bank rate cuts, the weakness of the pound, increased government spending and "the natural ways that an economy stabilises during a recession", could add 5% to GDP. That would be some turnaround and furthermore, the UK’s current account deficit narrowed in the fourth quarter of 2008 to £7.64bn.

Well, the statisticians and the experts may see the pot as half full or half empty but on an unrepresentative sample of a single visit to the grand city of Lincoln (in whose magnificent cathedral the De Vinci Code was filmed), the high street was positively buzzing. So also was the Mexican restaurant which is the nearest we get to wonderful Spain these days. Something, somewhere does not quite add up.

Gilt Auction Fails

3rd April 09 - Gilt auction fails

Yesterday we talked about the apparent dichotomy in top-level economic policy as between the views of the printing money, Governor and the UK prime minister. It seems that the remarks made by the Governor about the need for caution have been the main cause of a failed government bond auction. The first failure since 1995. Many times in this diary we have speculated as to where all the buyers of new government bonds were to be found especially in the light of changing attitudes by the likes of China and India. The yields on bonds soared to levels not seen since the Bank of England announced its £75bn QE programme. Mr King (the Governor) had said that he may hold back from spending the full sum if the economy and inflation recovered sooner than anticipated. The latest official statistics had given some indication of this trend.

The uncertainty as to whether capital markets were balking at the sheer amount of debt intending to be raised by the UK almost caused another failure. The B of E was concurrently putting £3bn into the market by buying gilts as the latest tranche of its QE programme. Offers totalled just 1.4 times the Bank’s bid compared with a cover of more than 10 times previously. It’s a funny old world. The (failed) attempt to sell £1.75bn gilts would have sucked cash out of the economy due to pension funds, for example rather than overseas sovereign states, buying this safer Government debt rather than invest in company bonds. At the same time, the B of E is buying from essentially the same people over the next three months its stated £75bn of gilts issued previously.

A better man than me would have to work this out. Two sources that may have done so are first the hedge funds by arbitraging the process and secondly our old friend Tim Congdon of Lombard Street Research who described the whole process as "quite idiotic fankly". He repeated that if B of E simply issued fewer gilts in the first place, then so called QE would be achieved by buying bank debt. Of course since 1998, the Debt Management Office (the organ that issues gilts) has been part of the Treasury and not as hitherto the B of E.

The fog clears: it’s obviously King versus Country again.

King to Queen 1 - Check.

2nd April 09 - King to Queen 1 - check

Except as all you chess players will know, you cannot put yourself in check. Nevertheless, it was a daring move. A second daring move in fact. The diary entry dated 25th March 09 covered the gist of The Bank of England Governor Mervyn King’s speech at the Mansion House in London. This time he was appearing before the Treasury select committee and after which he called on the Queen to have a chat - at her request.

Mr King told the committee that Britain cannot afford further tax cuts or rises in public spending because of the present state of the nation’s finances. The point about taking this extremely risky chess move is that almost in the same instance the Prime Minister was calling on other countries to deliver "the biggest financial stimulus the world has ever seen" and since this appears to include the UK, the paradox is obvious. Mr King’s warning took this form "I’m sure the Government will want to be cautious in this respect (borrowing more). There is no doubt we are facing very large fiscal deficits over the next two to three years. Given how big those deficits are, I think it would be sensible to be cautious about going further in using discretionary measures to expand the size of those deficits. The level of the fiscal position in the UK is not one that would say - well, why don’t we just engage in another significant round of fiscal expansion."

All this is very serious stuff indeed. Some commentators are saying that the cost of bail-outs alongside all the economic measures could cause Britain to lose its top-level credit rating that in turn would raise the prospect of calling in the IMF. Most chilling of all is an expression used by Mr King at the select committee hearing. In a remark reminiscent of the famous "known unknowns and unknown unknowns" speech by Donald Rumsfeld, he said he had to distinguish between "unconventional unconventional purchases" and "conventional unconventional purchases". Scared or what!

Of 12 Noughts Preceded By a 1.

1st April 09 - Of 12 noughts preceded by a 1

The latest American casino big-hitter strolled in with a grin and punted a cool one trillion dollars. Someone calculated it is enough to buy out Switzerland, Austria and Greece combined. Actually, that is quite an idea. Now that the monetarists have caused a nation’s taxpayers to own just about everything in that nation, why not print more dosh and use it to buy up whole nations? In fact, the US and UK could combine forces and buy up Western Europe. On second thoughts the German chip could well stick in the wager’s throat and cause a nasty seizure at the table.

You need another cold compress for this one. There is to be a Public-Private Investment Programme (please do not get thrown off the scent already by confusing this with the UK disastrous financing partnership). Who can remember the original toxic fund of $700bn? Well, from that is to be allocated up to $100bn to buy up loans from banks. Then, auctions will be held to entice private investors to pile into the debt. Why would they do that since by definition, the debt is rubbish isn’t it? The bait is twofold. First, the private financing will be guaranteed by up to six-fold and secondly, the sale process is by auction so that the market itself will set the price of the assets. Of course, if all the bidders "low-ball" the selling banks may well have to write off what is left on their balance sheet. The programme is to be called "Legacy Loans."

A second programme is called "Legacy Securities" which will have the objective of creating a market for illiquid mortgage-backed securities. Again the idea is to combine private capital with state funded sources and with considerable leverage from the Federal Reserve. Investors can receive up to nine times their investment as a state loan.

It has taken a full five months for this sort of detail to emerge, how long for it to work - or fail? Economist Joseph Stiglitz, quoted before in this diary, said that the whole plan is "very flawed" and "amounts to robbery of the American people."