Financial Crisis

Comment by John Poynton on Sep 30 2008, 14:14

I am concerned that we are missing opportunities in the way we are tackling the credit crunch crisis.

First I must confess that, as a retired accountant, I have no direct experience of the toxic trading instruments that are causing all the trouble. However a certain amount of common sense added to what has been described in the press suggests that in essence they are just bundles of mortgages, with lists of names, addresses and repayment schedules attached. Indeed if that were not so then how would they collect the repayments or deal with the defaults? It is their income stream that gives them a value. If my assumptions are wrong here, then please someone who knows enlighten me!

The current proposals appear to involve the central bank taking on board the whole bundle and estimating in advance what proportion might go bad. Not only is this forecasting process uncertain, but the uncertainty could continue to undermine interbank lending. It is likely the banks are still overvaluing these assets their books.

However, I would have thought that if these mortgages can be bundled up together in the first place, then they can be unbundled again now. If instead the approach were simply to fillet out the bad mortgages as and when they default, and transfer just those to the central bank, then we could be dealing with very much smaller figures.

Furthermore, if the central bank were to guarantee it would always take on board defaulting mortgages, then all uncertainty would be removed. The central bank would substitute the monthly repayments to the lending bank with loan transfers. The cost of the loan could be at a penal rate, but the fact that sums equal to the defaulted mortgage repayments each month would continue to be received by the lending bank would ensure that its liquidity remained sound. Later, when the recession is over and the flow of defaults has dried up, the banks could then recapitalise either in the markets or through partial nationalisation (issuing new additional shares to the government rather than compulsory purchase of existing shares as was done with Northern Rock!), and the central bank would get its money back. The taxpayer would be buying into the bank at a low price and would almost certainly profit on resale later.

But let’s take this one crucial step further. If the banks can deal with their defaults in this way, then they would no longer need the right to repossess. Under this arrangement WE CAN STOP REPOSSESSIONS OVERNIGHT by making them illegal. This not only avoids all the distress involved to the home owners, it also stops thousands of people being tipped out onto the streets when there is already a critical shortage of social housing.

So what, you may ask, is there then to stop people from defaulting anyway when they don’t absolutely have to? The answer is that for defaulting mortgages the repayments would be collected by the Inland Revenue. The taxman would reduce the homeowner’s take-home pay to the benefit levels and transfer any excess after tax to their mortgage account. This is no different to what a creditor would receive in a court of law. In the short term it might not yield much if anything, but in the longer term most people’s finances would recover, especially as they would continue to own their houses. Thus ultimately these mortgages would only finally go bad if the homeowner died or declared bankruptcy.

Finally, two proposals to ease the pain in the short term:-

1). Extend entitlement to housing benefit to those paying interest-only mortgages. The Rent Officer would still limit the entitlement by reference to typical rents in the area and by family size, so those in larger properties would still have to downsize, but poorer residents would receive critical help. Bear in mind that they would be entitled to this anyway were they to have to rent following repossession, so in effect it does not involve any additional cost to the taxpayer.

2). In one of my submissions to the working parties a couple of years ago I proposed a system of guarantees for private landlords so that they could let to tenants on benefits or with dodgy credit histories with confidence. At present landlords avoid such tenants like the plague. I won’t go back over the details here, but simply observe that such an arrangement would provide relief not only to prospective tenants who currently have to wait for some bureaucrat to get out of bed the right side in the morning, but would also help buy-to-let owners who now find themselves in difficulty.

I hope this helps.

Comment by Mark.esq. on Sep 30 2008, 17:11

I find it very hard to believe anyone from the establishment or the financial bodies When the catalyst to this economic downturn is the WAR. The war created the instability for The Oil price to double. This lead to all manner of commodiities to rise. The interest rate was trebled in the USA to replace the supposed 3 Trillion that the state have borrowed and taken from the economy. No wonder the Bankers are getting massive pay offs. Is it to keep their mouths SHUT.

Comment by Jonathan Whitney on Sep 30 2008, 19:27

Debt is serious in government. In 1997 it was 413.2 billion, ten years later, this has risen to 618.8 billion. I think the Conservatives will sort out this mess. Meanwhile council tax freeze will seriously help lots of people.But more importantly, Conservatives will look after the nations finances much better than the current administration.

Comment by John Barker on Sep 30 2008, 20:06

I also thought that David Cameron's speech was quite unique in its honesty and integrity and deserving of much praise. I also was impressed by some frank comments in an interview with BBC Wales about the shortcomings of the Welsh Assembly. It is time to be honest about the failure of devolution and to move away from the local conservative view that "we are where we are". These are tough times and require tough decisions. I look forward to the review on devolution and hope Lord Roberts will be as honest as the leader. If we have to cut public spending where better to start than at the Welsh Assembly.

Comment by FurtiveFerret on Sep 30 2008, 20:06

This is the speech that Darling and/or Brown should have made instead of dithering and expressing vague hopes that, somehow, all will be well.
If they believe that their actions (or inactivity) has achieved economic security and well being they should seel a second opinion and call a General election before the Country is completely in ruins

Comment by David Belchamber on Sep 30 2008, 20:09

Two things need to happen quickly: confidence has to be restored to markets and funds must flow again between banks; the two are linked.

The lack of hype from Congress today was welcome and the markets calmed down a bit. Possibly we should close the markets for a day or two to allow some calm debate to take place.

For the future I could envisage a 3 tier banking system emerging: a premier league of the big five HS banks, a second division of mutual bulding societies and a third division of more adventurous commercial banks.

The first two tiers would be ring-fenced by the depositor safety net already in place (but at £50K) and the third at £35K.

The BoE should be the lender of last resort and should be the sole regulator of the whole banking system.

The first two tiers could sign up to be able to make use of the BoE's lender of last resort facilities on condition that they would submit to the regulation of the BoE with regard to liquidity and capital requirements. One aspect of regulation would be that every executive director would have to be familiar with - and approve - every product offered by their bank.

It would be recognised that banks in the third category were on their own in a commercial sense, though depositors would have some protection.

Comment by Typo on Sep 30 2008, 20:15

The idea of unbundling is great, but of course the big banks didn't get where they are today by considering the needs of the individual. Maximising profit is all about economies of scale, and to have to deal with people one at a time is far too expensive. It means using people who can have meaningful interactions, and since remuneration was driven up by trade union demands they cannot be afforded.

Comment by Leon on Sep 30 2008, 20:45

great speech :)

Comment by Typo on Sep 30 2008, 21:04

The idea of unbundling is wonderful, but the big banks didn't get where they are today by dealing with people one at a time. Maximising profit means using the economies of scale. To deal with individual cases involves having meaningful interactions which needs people with personal skills. Since wages and salaries have been driven so high in the last half-century this is considered unaffordable.

Hence the rise of commercial banking, and the demise of the market in personal savings. The instant attraction of easy credit available to all is much more acceptable than the painstaking persuasion needed to steer people towards putting something aside for a rainy day.

The old-fashioned idea of the building society account or the savings policy, which helped fund the home-owning aspirations of our fellow-citizens, is not for the twenty-first century. The less able members of society who will need their hand held when navigating the maze of go-compares are simply discarded to the underclass where they will sink out of sight. Or maybe there will be a few kindly souls out there who, out of the goodness of their hearts, will help out with advice on a voluntary basis. But then the will have to be regulated, won't they, and these expensive regulators have to be paid. By whom? Oh no, not the taxpayer. It will have to be themselves who put their hands in their pockets to pay for the privilege of helping others. And they will have to put money aside to compensate their 'clients' when they make a mistake ... and by the way they will have to help cover the mistakes of the Northern Rocks and Bradfod & Bingley's of this world as well. But hold on ... haven't we been here before? That is where the thousands of what used to be known as insurance brokers, or more recently independent financial advisers, came unstuck and went to find something less stressful to do.

Comment by June on Sep 30 2008, 21:36

Congratulations on delivering something to give at least hope in a bleak time. Offering a helping hand is a compassionate offer and it will be interesting to see how Mr Brown treats the offer. I wonder if the opposition in America will help Mr Bush or simply practice topiary and then fell him.

As for here, I have to admit to not understanding quite how all the Labour promises of ‘we will survive through taxes’ will work – from articles last week. So many people are becoming unemployed through no fault of their own (not all are / were high paid bankers – there were many more support staff and similar) where will the taxes come from? You say, ‘Our principle is clear: we must protect the taxpayer where possible and stabilise the system where necessary’. I wonder how you can protect the taxpayer when Labour couldn’t – although as a taxpayer, I certainly hope you can!


Putting heads together and using a different approach is probably the right answer, and I applaud the offer from the blue corner. It is going to be a hard battle, but if red and blue are on the same side (for this part of the exercise) it may well work.

Comment by No Display Name on Sep 30 2008, 21:42

I've been a life long supporter of the Conservatives but I have NEVER beleved so little in a politicians ability to deal with this economic crisis as I do with George Osbournes and David Cameron. They've been great the past year but this crisis makes them look like polticial minnows. I don't like Gordon Brown - but I trust him here. Cameron and Osbourne would be in real trouble if they were in charge - they're clearly not up to the job.

Comment by don,t get me started on Oct 1 2008, 07:58

Dear sir I am in full agreement with your comments.Since this is the first time I have ever made a comment I do hope you will forgive me for taking this opportunity to give Mr Cameron some advice given the jibe from gordon brown earlier this week that this is not the time for novices my response is that you can't teach an old dog new tricks Since the tricks he has pulled over the past 10 years have have more than helped get us into this mess maybe its time for a new dog that spends less time in his basket.To summarise 3 terms in office labour have adopted the washing machine approach to politics WASH RINSE AND SPIN

Comment by Span Ows on Oct 1 2008, 08:42

Wow, after that comment my "well done on a good speech" seems a bit weak!

If the above suggestions are workable then it sounds very good indeed and more importantly a vote winner!

Comment by AJC on Oct 1 2008, 11:20

I have just read DC's speech and it was good to read the comments about leaving behind party political differences to address the current financial crisis. What I would like to hear now is some humility from this wretched administration laughingly known as 'The Government' as regards how we got here. Unfortunately, I am sure it won't be their fault!

Comment by John Poynton on Oct 1 2008, 15:06

Further to my blog yesterday, it has been pointed out to me that I did not make clear in my proposal that the unbundled bad mortgages would not change ownership. Only an exclusive agency right to collect outstanding repayments would transfer to the central bank, in return for the central bank’s loan guarantee, and any money collected by the Inland Revenue would, after perhaps the deduction of a small handling fee, be passed to the central bank for credit against the loan account. This way the homeowner’s repayments are credited to the lending bank, the owner of the mortgage, as they should be.

This is important as part of the object of this exercise is to avoid having to use current, uncertain valuations of these bad mortgages as a basis for transfer.

Comment by jeano on Oct 1 2008, 16:05

I am old enough to remember that
every time Labour regain power
they inherit a healthy economy and
then squander the proceeds without reformiing institutions and practices,
whilst creating ever more jobs in
the public sector. They then leave
office with huge problems for the
Tories to put right.
Jean

Comment by IKH on Oct 7 2008, 15:58

It has been obvious that the British Banking system has needed a rescue
package, long before the US came up with the idea and certainly since the HBOS
debacle. Such a package should leave the toxic assets with the banks, who
are best situated and staffed to manage them. The Government should make
cash available, in the form of equity to allow the banks to write down/off
the worst of these toxic assets to strengthen the banks balance sheet's.
The Government should also undertake not to sell the equity for at least 5
years. This will help provide stability for the markets.

The Government's current 'leaked' proposal of a 50 billion package is
another example of Gordon doing what he does best, dithering again! It is too
little and very late. I suspect that 250 billion, at least, will be necessary,
as a first tranche. It took 150 billion for just Northern Rock and B & B,
all be it that it was for full nationalisation. And leaking the package
is just frittering away the value and confidence that a surprise announcement
would give the markets.

The above is just first aid and will be completely ineffective unless we also
deal with the underlying cause. The property market, money markets and credit
derivatives all need to be kick-started or the banks will not be able to trade
their way out of this crisis. Cash has fled from the money markets to government
backed bonds and GILTS. The BoE ( Bank of England ) needs to be able to take
deposits ( overnight, 7, 30, and 90 day ) from Corporations at rates above GILT
rates but less that market rates. It would then lend this to the banks, not at
base rate, but at LIBOR rates. This would not only greatly increase the
liquidity of the money markets but also help to kick-start the London Inter-Bank
market and help bring LIBOR down. The deposits could be funneled through the
banks to the BoE but it would have to be done in a 'risk free' way i.e. through
trustee accounts. This would alleviate much of the administrative burden for
the BoE.

Finally, we must get the mortgage market un-frozen. This means mortgage
securitisation. Again, the BoE should be used as the catalyst. It should but
mortgage portfolios from primary lenders, securitize them and sell them on to
the market ( it goes almost without saying that these should only be
'high quality' mortgages ). The work and admin being again delegated to the
banks.

Once the markets begin to work, the BoE can easily ease itself out by shading
its rates so that the banks undercut it and out compete it for business.

What we desperately need is action. And we need it NOW. We can not afford to
'wait and see' what happens in the USA. We can't afford to be blocked
by idealists like those US republicans that tried to block the US Package.
Otherwise we risk a depression that will make the 1930's look like a minor
setback.

/ikh

Comment by Mr. P. Scargill on Oct 8 2008, 15:42

It would appear the BoE is no longer independent, given it's sudden rate change.

Also, current government intervention has been short sighted.

1) Banning of short selling in banking and financial stocks:
In standard (non-derivative) short selling there are 2 counterparties. One who owns the shares (e.g. pension funds) and one who borrows the shares (e.g. a hedge fund). The lender has the intention of maintaining their holding but receiving extra income via short term loans of the stock.
Without this extra income and with the valuations plunging, why would they continue to hold these assets?
Result: Further drop in bank share prices as pension funds try to liquidate their positions.

2) "Part-nationalization" of major banks. Any shareholder still holding banking shares will now run a mile, we all remember what happened when Railtrack was re-nationalized.
Result: Even further falls in the prices of bank shares.

Comment by L. Simpson on Oct 10 2008, 17:29

Unless all political parties can persuade the media to stop or reduce the amount of frightening news about the Financial Crisis the public and the Stock Exchanges will not simmer down and let the financial problems resolve themselves in an orderly fashion.

Comment by Stephen otterburn on Oct 26 2008, 08:28

The Labour Goverment failed us all by not including property and other assets in the inflation remit of the Bank of England; is a Conservative Govement going to make the same mistake?
House price inflation did not cause the present crisis but was a symptom of a flood of cheap money. Brown made a fine decision to give the BofE control over setting interest rates but then failed us completely by excluding, inter alia, house prices from the remit; had they been included interest rates would have been much higher through the 90s and 00s and forced action to the stop the house price bubble inflating.
If an asset price bubble arises it is a sign of an imbalance in the economy of which warning should be given by higher interest rates imposed by an independant BofE. This in turn provides the incentive for Government action if required to address the problem. This may make the politicians life less comfortable but it would make the rest of us a lot safer.

Comment by John Poynton on Oct 27 2008, 14:58

Labour’s policy of massive public spending to regenerate demand is profoundly mistaken. The Keynesian multiplier effect depends largely on the propensity to borrow and spend, which in current circumstances is – non-functional, and even if it were I would guess it is much more sluggish than it used to be because we import more, pay much higher taxes and the current low propensity to save could well increase. This is what the Japanese discovered in the 1990’s when their Keynesian spending program produced very little other than a massive debt headache, though in their case the bug was deflation.

Even Keynes himself initially overlooked the fact that these programmes have eventually to be funded – it was only after the war that he realised this, when he had to go cap in hand to Washington and beg for the Marshall Plan. This debt to America was only finally paid off a year or so ago. There will be no Marshall Plan this time.

The best example of the multiplier effect in action took place after the 1987 budget, when Nigel Lawson cut taxes dramatically. Perhaps thinking that monetarism had replaced Keynesianism, Lawson’s officials told him that his budget would have no inflationary impact. In the sense that the budget itself was monetarily neutral (it was fully funded) they were correct, but they forgot the multiplier effect. As soon as people found the extra, unexpected money in their pockets they used it to pump up their mortgages, thus busting the money supply and causing the inflationary boom.

In this respect there is no difference between Keynesianism and monetarism – they are complementary, not alternative. The cutting of interest rates has exactly the same effect on the amount of money in peoples’ pockets (given that most of us have mortgages – it would be different in Africa), with exactly the same consequences. The mechanics are identical, though where fiscal policy involves tax cuts the effect is rather more immediate than where it involves expenditure increases, due to delays in the circulation of money between buyers and sellers.

Gordon Brown has clearly failed to understand this, because from 2001 onwards he made exactly the same mistake. And that guy calls himself an economist?! I can understand Nigel Lawson falling into this trap because he was implementing monetarism (and tax cuts) for the first time. When you are in virgin territory the way is unlit and potholes await. Brown on the other hand had over ten years to try and figure out why inflation took off in the late 1980’s, and he still didn’t get it.

Of course he could claim that he thought that the inflationary consequences of his expenditure boom would be offset by global disinflation and the effects of immigration undermining wages levels in this country, and to a large extent that did indeed happen. But even so, the BoE still had to increase interest rates significantly and persistently from 2002 onwards, which in turn pushed the pound through the roof making it uncompetitive, which in turn undermined economic growth.

Everyone is now getting paranoid by whether or not our economy is going into recession, defined as zero economic growth for two successive quarters. This definition is useless. The total growth rate consists of three elements: inflation, population growth, and real increases in per capita standards of living. Personally I would prefer to define a recession when just the last of these turns negative, which it did long before the credit crunch broke.

That total growth remained steady at about 3% until around 2006 disguises the fact that inflation and population were growing at the expense of real standards of living. Nor do the figures indicate any benefits deriving from immigration – in fact their principal effect has been to expand demand for public services even faster than Brown could spend money on them.

Fiscal policy and monetary policy must therefore be kept in balance. Fiscal policy can be regarded as the ‘rough tuning’ of demand, set once a year in the budget, and monetary policy the ‘fine tuning’- reviewed monthly by the MPC. The externals are debt management from the former, and exchange rate management from the latter. The ideal therefore is a balanced or surplus budget to control inflation and low interest rates to maintain growth through a competitive exchange rate. And that is what John Major’s government achieved in the mid 1990’s. Brown then went and reversed both policies!

David Cameron is of course right to say that, if we are going for a fiscal deficit, then tax cuts will have a much more immediate and potent effect on demand than public spending increases. But even this will be blunted by the continuing unwinding of leverage in bank lending. I am also concerned that these decisions are being taken before there is any sign from the inflation figures that demand is moderating. We are jumping the gun. Who is to say that oil prices won’t turn up again, or that an exodus of immigrants won’t lead to wage inflation, or that the BoE hasn’t overdone refinancing? Trying to second guess the market is how you lose your shirt.

It would seem much more sensible to me to restrict the re-stimulation of the economy to monetary policy. For so long as the banks are unwinding at least, the BoE should consider direct lending using the banks as agents, perhaps just for specific products such as first-time mortgages or business loans to begin with. Risk could be shared on a basis to be agreed, perhaps in proportion to the interest earned. Indeed I would go further and develop monetarism onto a regional basis, setting different base rates for different regions for these products depending on local inflationary conditions. Direct lending would make this possible, and then we really could look forward to ending the north-south divide.

We should also re-jig our inflation statistics to include housing but exclude direct imports and interest rates, and we should do that region by region. It is I am sure most likely that inflation will turn down first up North, if it has not already done so, and direct lending would enable us to respond to that much more quickly. Global inflation on the other hand is beyond our control, and in any case import price rises do not strictly speaking constitute monetary inflation.

Regional demand management would also enable us to set the MPC a minimum unemployment level as well as a maximum inflation level. Never again must we find ourselves vacuuming up millions of immigrants just because we could not prevent our labour markets from drying up in the South. I have no difficulty with temporary immigration or the principle of free movement, but we should discourage settlement by imposing a moratorium on citizenship and withdrawing entitlement to the personal tax allowance from non-citizens.

As for myself I am still feeling chuffed that I blogged the idea of partial bank nationalisation two days before those blokes at Standard Chartered thought of it (see above)! Until disabused of this notion I shall assume they saw my blog and ran with it! Actually, the issue of shares is something every accountancy student learns for his exams – what is really intriguing is why Gordon Brown didn’t know about it for Northern Rock or B&B?!