A passive approach to bank stakes is inadequate

By John Kay

Published: November 25 2008 19:32 Last updated: November 25 2008 19:32

Governments of the world are becoming major shareholders in their financial institutions. The British government owns two mortgage lenders – Bradford & Bingley and Northern Rock – is likely soon to hold a majority of the capital of the Royal Bank of Scotland, and to be much the largest shareholder in the combined HBOS/Lloyds TSB. The US government has a dominant holding in AIG, one of the world’s largest insurers, and will soon hold a similar position in Citigroup, making it the biggest financial institution of all. Fortis and ABN Amro are owned by Benelux governments. And so on.

Early socialists must be chuckling in their graves. But this government control of the commanding heights does not represent the triumph of socialism over capitalism, but the necessity of pragmatism in the face of failures of capitalism. Governments do not want to own these stakes, and are not quite sure what to do with them.

Nationalised financial institutions have often been badly run businesses which served neither their owners nor their customers well. But recent experience has shown that privately owned financial institutions have often been badly run businesses which served neither their owners nor their customers well. One might argue that the private businesses served their customers better than their owners; while the state-owned ones served their owners better than their customers. Such are the inherent contradictions of capitalism, as Marx would have put it.

The British government has perhaps the clearest strategy. It has set up an organisation called UK Financial Investments. The intention is that UKFI should act as a relatively passive shareholder in these businesses with a view to a quick realisation. UKFI is modelled on the Shareholder Executive established five years ago to hold government stakes in other companies. The reports of the Shareholder Executive read rather like the updates a private equity house might prepare for investors.

But this answer is not adequate. The problems are evident in these reports from the Shareholder Executive. The government owns businesses such as Royal Mail and the Nuclear Decommissioning Authority for a reason. The rationale of public ownership is that there is a strong public interest, not just in the financial returns from these activities, but in what these businesses do and how they operate. The government does not, cannot and should not have the same kind of relationship with the companies it owns as a private equity owner.

That does not mean that the Shareholder Executive is a bad idea. Officials in government departments are often ignorant and naïve when faced with issues that are the day-to-day concern of private equity professionals and investment bankers; their expertise needed reinforcement. But while the government has an interest as investor, that cannot be its only interest: if it were the only interest, then government should not be an investor at all.

So with banks. The government will not recapitalise Woolworths because it matters little to the wider economy whether or not Woolworths stays in business. The government does recapitalise banks because there is a vital public interest in the continued operation of the payment system and the availability of finance to small- and medium-size businesses. So the primary purpose of the investment is not to ensure that the taxpayer gets its money back – although that issue should certainly not be neglected – but to ensure that these ordinary banking functions operate well.

But no one who talks to small business owners today can believe that that objective is being met. If it was much too easy to get loans in the salad days, it is much too difficult to get them in the locust years. The consequences of the loan restrictions are plunging the non-financial economy into depression. If there are concerns over the availability of mortgage finance – and there should be – then it is absurd to run down the very efficient mortgage administration activities of the two mortgage banks the British government owns. We taxpayers have rescued these financial institutions for a specific purpose, and we should use our stakes in them to insist that this purpose is fulfilled.

johnkay@johnkay.com

Darling’s Christmas present conceals a debt trap

By Simon Ward

Published: November 25 2008 20:02 Last updated: November 25 2008 20:02

Alistair Darling’s emergency Budget is pregnant with dangers. It will not achieve his objectives of shortening the recession and hastening recovery while the borrowing the UK will have to undertake will impose major costs on future taxpayers, endangering the long-term health of the economy.

On the face of it, Mr Darling is delivering a significant economic stimulus in 2009-10 through his temporary VAT cut and other measures. The Treasury reckons cyclically adjusted net borrowing will rise by 1.9 percentage points of gross domestic product, the largest increase since 1992-93. This will contribute to record headline borrowing of £118bn in 2009-10 or 8 per cent of GDP.

The form of the package and its temporary nature, however, imply a much smaller impact on demand. Most consumers base their spending on long-term income expectations. Current income is a key factor only for families with no savings or credit. A temporary tax cut applied across all families paid for by higher future taxes may not have a significant impact on consumption. Measures targeted at savings-short, credit-constrained people would have a greater chance of success, but the rise in spending would be partly offset by cutbacks by others anticipating lower future post-tax incomes.

Fiscal actions financed by higher borrowing can deliver a short-term stimulus. Policies must, however, be designed to enhance the economy’s long-term supply potential, thereby raising long-term income expectations. Examples include marginal tax rate cuts, which stimulate entrepreneurship and effort, and public investment in projects promising high returns such as transport infrastructure.

A temporary VAT cut is not targeted at people more likely to spend any gains and has no positive impact on the economy’s long-term supply potential. Consumption will rise in the months before the lower rate is withdrawn but fall by roughly the same extent afterwards. The temporarily higher demand will be met either from imports or a rundown of stocks, with no impact on domestic production.

Higher borrowing can have monetary effects; a rising deficit financed by bank borrowing rather than bond sales would boost the money supply, representing a “net injection of cash to the economy”. The same positive monetary impact, however, could be achieved simply by “underfunding” the existing deficit, without further fiscal largesse. The authorities appear to have rejected underfunding as an option.

Regardless of whether the effect of Darling’s package is large or small, it will be fully reversed in 2010-11 and beyond as the VAT cut is reversed and higher national insurance and income taxes kick in. Cyclically adjusted net borrowing is projected to fall by a combined 2.9 percentage points of GDP in 2010-11 and 2011-12. This could undercut the Treasury’s hopes of GDP growth of 2 per cent and 3 per cent respectively in these two years.

So it is possible that by 2011 the economy will be no stronger than in the absence of Mr Darling’s measures yet the public finances will be worse, with the net debt/GDP ratio on the Treasury’s own optimistic projections reaching 53 per cent by March 2011, even excluding the impact of recent financial sector rescues.

Servicing this debt will eat significantly into the nation’s resources. The Treasury projects a rise in debt interest from 1.7 percentage points of GDP in 2008-09 to 2.4 percentage points by 2013-14. This increase is the equivalent of £10bn in today’s prices. Put another way, the increased cost equals a 2.5p rise in basic rate income tax.

Even this could be too optimistic. The Treasury assumes the interest rate paid on debt averages 0.9 percentage points less than the annual GDP growth rate in nominal terms between 2010-11 and 2013-14. Investors may, however, demand higher yields to induce them to hold more gilts. If the average interest rate were to equal nominal GDP growth, debt interest would soar to more than 3 per cent of GDP by 2013-14.

The danger is of a debt trap – a vicious circle in which the debt/GDP ratio explodes as rising debt interest causes ever widening budget deficits. A debt trap develops if two conditions are fulfilled – the primary budget balance, which excludes debt interest, is in deficit, and the debt interest rate is greater than money GDP growth. The Treasury’s forecasts show an average primary deficit of 3.3 per cent of GDP over the next five fiscal years. Even a modest rise in gilt yields would cause the debt/GDP ratio to explode.

The writer is New Star Asset Management’s economist and strategist

Copyright The Financial Times Limited 2008

Taji Mustafa debates with Tory MP

Taji Mustafa debates with Tory MP - whose leader calls for a ban on Hizb ut-Tahrir

London, UK, November 24 2008 – Conservative MP Philip Davies shared a debating platform with Taji Mustafa of Hizb ut-Tahrir Britain in Bradford last Saturday (23/11/08) despite David Cameron’s slanderous populist calls for a ban on Hizb ut-Tahrir and Cameron’s refusal to take their challenge to an open debate. It is clear that he cannot even convince his own MPs on this issue as Mr Davies preferred to argue and debate ideas - ignoring Cameron's hysterical scaremongering - in a lively community debate entitled ‘Has freedom gone too far?’.

The debate questioned the effects of liberal values in western societies - as exemplified by the recent Russell Brand/Jonathon Ross insults fiasco. They also discussed the Iraq war and the killing of over a million Iraqis in the name of bringing ‘freeedom’ and democracy to the Middle East, as well as the torture, rendition and 28 day pre-charge detention practised by western governments who preach ‘freedoms’.

During the debate, Philip Davies made it clear that he is opposed to the liberal interventionist export of democracy and liberal values by the gun, as supported by some in the West including David Cameron who supported the invasion of Iraq. Taji Mustafa highlighted growing questions in the West about the effects of liberal values and why people in the Muslim world increasingly support the re-establishment of the Caliphate state so they can once again live by the Islamic values of accountability and responsibility as opposed to the moral-relativism which has lead some in the West to support lewd insults to a 78-year-old man as ‘edgy comedy’.”

After the debate Taji Mustafa, media representative of Hizb ut-Tahrir Britain, said, "David Cameron spreads lies about Hizb ut-Tahrir – hiding behind parliamentary privilege. However, his colleague Philip Davies MP was willing to share a platform with a member of Hizb ut-Tahrir, for the second time, and debate issues."

"Cameron, it seems, believes in the kind of ‘freedom’ that calls for the banning of Islamic political organisations and shutting down debate, but cannot convince his own backbenchers to accept this. One wonders if he will now promote the same kind of ‘freedom’ within his own party and ban his backbenchers from speaking? We will see.”

"For our part, Hizb ut-Tahrir is happy to debate with both moderate and extremist Conservative MPs, because we believe in debate, the strength of our ideas and our vision of a Caliphate for the Muslim world”.

Brown's licence to print money - letters

George Monbiot misses the central point about the build up of surpluses and deficits that Keynes's plan would have prevented: they are a consequence of a refusal to share wealth in both the surplus and deficit states (Keynes is innocent, November 18). For example, the growing wealth in China and oil-rich Arab states was not redistributed to their own citizens, but was used to buy assets in places such as the US and the UK, that were intensely relaxed about people getting filthy rich. Many people in the US and the UK were not really better off, but sustained the illusion by borrowing all that money that was flowing in. Their debt got parcelled up and parcelled on - until the music stopped.

We must make sure it's not the poor who pay the piper. The national economic council that Gordon Brown has set up has government departments and businesses and Oxbridge advisers on it. What chance the pre-budget report will be pro-poor and start to fix the problem?

Katherine Duffy

European Anti-Poverty Network

I am surprised at the naivety of the government, the opposition and most of your columnists. A crisis in capitalism serves an essential purpose. It wipes out the least healthy companies allowing the most healthy to thrive. The government should have allowed HBOS and RBS to go to the wall, allowing Lloyds, Barclays and HSBC to thrive. In the early 80s Mrs Thatcher faced a very unhealthy UK capitalism and had the right strategy. She accelerated the destruction of the weak and changed the UK from the weak man of Europe to one of the strongest.

Of course, unemployment will grow, but as long as we can provide new jobs and housing we will end up stronger.

It is equally absurd to reduce interest rates to 1%. Interest should be kept at a reasonable level, otherwise you are punishing the savers. This would also strengthen sterling and allow us to borrow on the international money market.

It is equally batty for the government to demand that banks lend to businesses and people at the end of their financial tether. Surely they can understand that banks are profit-making companies operating in a competitive market?

If the Conservative opposition had the vision of Thatcher, they could do us all a service by following her lead.

Ian Grigg-Spall

Canterbury, Kent

David Cameron would fail Economics 1. (A borrowing binge, November 18). The deficit caused by the current anti-recessional fiscal policy will be largely financed by monetisation of debt: in effect by "printing money". This mechanism is at the heart of Keynesian policy. It can, of course, be abused, and cause inflation if excessive, but in recession-threatened times it is the right thing to do. Borrowing to finance the deficit would raise interest rates, which would dampen the expansionary effect. It is only initially that a deficit appears: once expansion occurs, the deficit will fall.

John Levi

Abingdon, Oxfordshire

OK, so this recession story (Brown claims Tories are alone in opposing tax cuts, November 18) has now got three chapters. 1) Banks can't lend so Brown et al gave them tanker-loads of money. 2) Banks still can't manage it, so the Bank of England cuts interest rates. 3) Still not enough credit coming from banks so Brown et al will cut taxes, to be paid for by ... bank lending. Didn't Lewis Carroll write books about this sort of thing?

Bryn Jones

Bath

I was one of the people who lost out as a result of the abolition of the 10p tax rate. As I am now unemployed, I will also miss out on any compensating tax cuts. However, these tax cuts will have to be paid for by increases in the medium term - presumably when I am in work again, so I will have to pay for compensation I never received.

Chris Foreman

Alton, Hampshire

Your leader on the pre-budget report (November 21) rightly highlighted the economic benefits of retrofitting houses to make them more energy efficient.

The government must seize the opportunity to simultaneously tackle economic and environmental challenges by announcing measures to develop safe, clean sources of renewable power and improve efficiency in transport, manufacturing and buildings. This would create new business opportunities, thousands of jobs, tackle fuel poverty and reduce dependency on fossil fuels.

Dr Tim Jenkins

Head of economics,

Friends of the Earth

Over the last year energy companies have increased gas prices by over 50% and electricity costs by nearly 30%, causing many consumers to fall into fuel poverty. Because of this, there is likely to be an increase in winter deaths. We are calling on all the energy supply companies to give vulnerable consumers some peace of mind by knowing that winter fuel bills will be reduced. A failure to do so is likely to cost lives.

Lesley DaviesChair,

National Right to Fuel Campaign

Research, I believe by the Joseph Rowntree Foundation, focused on asking recipients of disability benefits what they would do with the extra money should their benefits be increased. All respondents mentioned services to enable them to live fuller lives, such as taxis, gardeners, hairdressers and home help. This seems a very efficient way of increasing employment while helping those most in need.

Jennie Millie

Ditchingham, Suffolk

My partner is an accountant. Last week we had a fiscal squeeze and this week it was fiscal stimulus. Should I now be looking forward to endogenous growth or is deflation inevitable?

Judy Debenham

London

US economy: Three steps to havoc

Larry Elliott analyses the three stages that have led to the economic challenge facing Barack Obama
Comments (7)

Larry Elliott, economics editor
guardian.co.uk, Friday November 21 2008 18.40 GMT
Article history

Not since Roosevelt in 1933 has an incoming US president had a tougher economic challenge to face than Barack Obama.

He is still piecing together his Treasury team but he doesn't need a pointy-headed academic to tell him the economy has hit the wall. The housing market is still crashing, unemployment is rising sharply, Wall Street is traumatised and it appears the life expectancy of another big bank, Citigroup, can be measured in days rather than weeks.

This is a crisis long in the making. And three big structural changes help explain the mess the US now finds itself in.

The first is that a profound shift in the balance of power between labour and capital over the past three decades has resulted in nugatory increases in real earnings for most people but massive rewards for those at the top.

The second is that the US is living beyond its means at every level. In recent years, it has spent $106 (£71) for every $100 it has earned.

The third is that Wall Street has grown in size and importance as more of America's manufacturing capacity has been exported overseas.

America, as the world's can-do society, found a way of making this work for a time. More women worked, which disguised the fact that male incomes were under pressure. Couples worked longer to maintain their spending. When both those avenues were exhausted, they took on more debt.
Borrowing was a readily available option because the shifting of production from North America to east Asia created big trade surpluses, particularly for China. Beijing had to do something with its export earnings and it parked a large chunk of them on Wall Street.

This influx of capital helped push down borrowing costs, while the cheap goods from Asia kept the lid on inflation and allowed the Federal Reserve to keep interest rates low.

Cheap money drove up house prices, so consumers used their homes as cash machines. House prices only continue rising if there is a flow of first-time buyers, and these were found by offering mortgages to those who would normally have been disqualified. These were risky loans which Wall Street disguised by putting them into a blender with good-quality mortgages and selling them on to anybody who would buy them. Many investors, including UK banks, did.

Inevitably, the housing bubble burst. The banks found they were sitting on huge, unquantifiable losses and by refusing to lend to each other set off a prolonged domino effect that has now reached deep into the heart of the American economy.

Policymakers have throw the kitchen sink at the issue. The Fed has cut rates to 1% and there was a $150bn (£100bn) tax cut in the summer. Banks have been nationalised and recapitalised. So far none of it has worked. The scarring economic memory of the US remains the Great Depression; as things stand the sub-prime crisis will run it a close second.

Lobby of Parliament - 'Justice for Palestinians'

Lobby of Parliament - 'Justice for Palestinians'

2-6pm on Wednesday 19 November 2008

Followed by a public meeting 'Time for Government Action' 7pm, Committee Room 10 in the House of Commons.

A lobby of parliament is being organised by the Palestine Solidarity Campaign, the Council for Arab-British Understanding and Jews for Justice for Palestinians on Wednesday 19 November to mark the UN international day of solidarity with the Palestinian people. Previous lobbies of parliament have attracted a significant level of support from solidarity organisations, faith groups, trade unions and other groups. This broad support is very important in demonstrating to MPs and the British government the wide range of organisations calling for peace and justice.

This year the lobby theme will be 'Justice for Palestinians', and will take place from 2-6pm on Wednesday 19 November.

DOWNLOAD A BRIEFING PACK (PDF)

The lobby of parliament will call on the British government to implement international law and press for:
• an end to the blockade on Gaza.
• Israel to end its occupation.
• the dismantling of Israeli settlements in the Occupied Palestinian Territories.
• respect for Palestinian sovereignty.
• the suspension of the EU-Israel trade agreement.

Ensure that your MP hears your views – please contact them straight away and ask to meet them on the afternoon of 19 November.

If you don't know who your MP is, please go to www.theyworkforyou.com

Make sure to let us know at the PSC office when you have made an appointment

Please help publicise this lobby as widely as possible. New leaflets are being printed – please contact the office for copies..

If you require any further information please don't hesitate to contact info@palestinecampaign.org or wattg@caabu.org.


The Lobby of Parliament is organised by:
CAABU - JFJFP - PSC

The Lobby of Parliament is supported by:
The following Trade Unions: ASLEF, BECTU, CWU, FBU, GMB, PCS, RMT, UNISON, UNITE and Action Palestine, Amos Trust, Association of the Palestinian Community in the UK, Britain Palestine Twinning Network, British Committee for Universities in Palestine, Christian Peacemaker Teams UK, Friends of Al-Aqsa, Friends of Birzeit University, Friends of Sabeel UK, The Green Party, Israeli Committee Against House Demolitions UK, Midlands Palestinian Community Association, Muslim Council of Britain, National Association of British Arabs, Palestinian Forum in Britain, Palestinian Return Centre, Pax Christi, Stop the War Coalition, War on Want.

Protect the people of the DRC

We're sure you have been watching with apprehension the unfolding humanitarian catastrophe in eastern DRC. Amnesty is receiving reports of serious human rights abuses, including unlawful killings of civilians, rape, and the recruitment of child soliders. And we would like to ask you to take action for the DRC.

The conflict in Democratic Republic of Congo (DRC) is one of the deadliest in African history. Since it began in August 1998, it is estimated that the fighting and its aftermath (poverty, disease, and malnutrition) have claimed over five million lives. In recent weeks, fighting has displaced at least 250,000 civilians, most of them women and children. These people are in a desperate situation, without sufficient food, water, medical supplies or shelter. Amnesty is calling for urgent reinforcement of the UN's peacekeeping force, MONUC, to protect civilians and to ensure people have access to humanitarian assistance. Please take action by visiting our website and calling on the UK government to ensure that the UN Security Council takes decisive action and pledges support to protect civilians in eastern DRC.

For all the latest information check here . We will update you on how you can take action but as the situation in DRC is fast moving we may need to ask you to take action at short notice.

Sincerely,

Amnesty International UK

Protect The Human

Academics are not immigration officials

guardian.co.uk, Monday November 10 2008 00.01 GMT
The Guardian, Monday November 10 2008
Article history

The new immigration rules for overseas students to be introduced in March 2009 by the Border Agency are very worrying (New points system, November 5). These rules would require universities to report any absences by overseas students from lectures, seminars or tutorials, or any failure to submit any assessment on time. In other words, the university is being asked to act as an immigration officer and set up a surveillance unit over these students. This goes far beyond the present monitoring of student progress systems in universities, which has as its basic purpose assisting students to reach their full potential.In our view it is hard to justify such detailed monitoring of overseas students, even for immigration control purposes. Surely the Border Agency just needs to know students have registered and are at the university? It does not need to have this constant monitoring. This police-like surveillance is not the function of universities, and alters the educational relationship between students and their teachers in a very harmful manner. University staff are there to help the students develop intellectually and not to be a means of sanctioning these students. The proposals are discriminatory as they apply only to overseas students and not EU students. They represent a possible breach of article 8 (right to a private life) and article 3 (degrading treatment) of the European convention on human rights and the Human Rights Act 1998. We would urge universities, MPs and others to join us in opposing these rules and calling for the government to withdraw them.

Ian Grigg-Spall Academic chair, National Critical Lawyers Group Sally Hunt University and College Union Tony BennProfessor Bill Bowring Birkbeck School of Law, London University Liz Davies Chair, Haldane Society of Socialist Lawyers

Academics balk at 'spying' on students to nail migrant scams

Polly Curtis, education editor
guardian.co.uk, Monday November 10 2008 00.01 GMT
The Guardian, Monday November 10 2008
Article history

Universities are being asked to set up surveillance units to monitor the movements of international students in a government-led crackdown on bogus student immigration scams, academics say. New rules to force universities to report overseas students who miss too many lectures to immigration officers will harm the academic-student relationship because lecturers are being asked to act in a "police-like" manner, according to a group of 200 academics and activists opposing the moves.

A letter to the Guardian, organised by Ian Grigg-Spall, academic chair of the National Critical Lawyers Group and signed by leading academic lawyers, the head of the lecturers' union and Tony Benn, claims that the rules could breach the European convention on human rights, which guarantees the individual's right to privacy. "This police-like surveillance is not the function of universities and alters the educational relationship between students and their teachers in a very harmful manner," it says. "University staff are there to help the students develop intellectually and not to be a means of sanctioning these students."

The rules will require all universities to obtain a licence to admit students from outside the EU. They will then have to sponsor students, who will be required to have their fingerprints taken and be issued with ID cards. Lecturers will have to report any student who misses 10 or more lectures or seminars. Students will also have to prove they have funds to cover fees plus £800 a month for the duration of their courses. Universities have separately raised concerns that the system of registering overseas students, which is planned to take place at six centres around the country, will struggle to cope.

About 350,000 overseas students attend British universities every year. Universities are heavily dependent on the £2.5bn a year they pay in fees.

Almost 300 bogus colleges have been uncovered in the past three years, many involved in immigration scams.

Sally Hunt, general secretary of the University and College Union, said: "We have grave concerns that new rules on monitoring foreign students have been pulled together without any consultation with the people who would implement them. We do not believe it is appropriate or effective to task colleges and universities with the policing of immigration."

A Home Office spokesman said: "Those who come to Britain must play by the rules and benefit the country. This new route for students will ensure we know exactly who is coming here to study and stamp out bogus colleges who facilitate the lawbreakers.

"International students contribute £2.5bn to the UK economy in tuition fees alone. The student tier of the points system means Britain can continue to recruit good students from outside Europe."

Preventing a global slump must be the priority

Martin Wolf

Every week, 50 of the world’s most influential economists discuss Martin Wolf’s articles on FT.com

In a more recent note, Professor Roubini predicts a combination of stagnation and deflation*. In doing so he points, with some glee, to the most recent analysis of the global outlook from JPMorgan Chase, once among the most bullish of analysts. Now, under the rubric “A bad week in hell”, JPMorgan states that: “Once again, we have taken an axe to near-term growth forecasts for the developed world and will likely follow up with additional downward revisions for emerging economies in the coming weeks. Already, our forecasts suggest that global gross domestic product will contract at a near 1 per cent annual rate” in the fourth quarter of 2008 and the first quarter of 2009.

JPMorgan expects shrinkage this quarter at an annualised rate of 4 per cent in the US, 3 per cent in the UK and 2 per cent in the eurozone. It is forecasting 0.4 per cent global growth in 2009, with advanced countries shrinking 0.5 per cent and emerging ones growing 4.2 per cent.
Given the near-disintegration of the western world’s banking system, the flight to safe assets, the tightening of credit to the real economy, collapsing equity prices, turmoil on currency markets, continued steep declines in house prices, rapid withdrawal of funds from hedge funds and ongoing collapse of the so-called “shadow banking system”, these forecasts even look quite optimistic. The outcome next year could be far worse.

If western governments had not intervened to guarantee and recapitalise banking systems, it would surely have been worse. Yet, as the charts show, even this has not halted the turmoil. Consider just two statistics: the capitalisation of world stock markets has halved; and, according to the Bank of England’s latest Financial Stability Report, mark-to-market losses on vulnerable debt instruments now amount to a massive $2,800bn (€2,240bn, £1,790bn)**.

So what should be done? Some would argue: nothing at all. The view is widely held, particularly in the US, that the world needs a big purge of past excesses. Recessions, on this line of argument, are good. People who hold this view also argue that governments caused all the mistakes. The market would, they insist, be incapable of the errors we have seen. To them, Alan Greenspan’s confession last week that “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders” was about as welcome as Brutus’s knife was to Caesar.

Intriguingly, the Bank’s Financial Stability Report provides some support for this view: back in 1900, US banks had four times as much capital, relative to assets, as they do today. Similarly, the liquidity of the assets held by UK banks has collapsed over the past half-century. Implicit and explicit guarantees from governments have indeed made the financial system more dangerous than before. The combination of such guarantees with deregulation has proved lethal. Moral hazard is far from meaningless.

Yet the idea that a quick recession would purge the world of past excesses is ludicrous. The danger is, instead, of a slump, as a mountain of private debt – in the US, equal to three times GDP – topples over into mass bankruptcy. The downward spiral would begin with further decay of financial systems and proceed via pervasive mistrust, the vanishing of credit, closure of vast numbers of businesses, soaring unemployment, tumbling commodity prices, cascading declines in asset prices and soaring repossessions. Globalisation would spread the catastrophe everywhere.

Many of the victims would be innocent of past excesses, while many of the most guilty would retain their ill-gotten gains. This would be a recipe not for a revival of 19th-century laisser faire, but for xenophobia, nationalism and revolution. As it is, such outcomes are conceivable. Choosing to risk such an outcome would be like deciding to let a city burn in order to punish someone who smoked in bed. Risking huge damage now in the hope of lowering moral hazard later is mad.

Everything possible must be done to prevent the inescapable recession from turning into something worse. Many of the needed actions were laid out in an article on the FT’s Comment page this week by Columbia University’s Jeffrey Sachs. I would stress five points.

First, as Oxford university’s John Muellbauer argues, deflation is a real danger***. Yet deflation is lethal for indebted economies. Today, short-term interest rates look far too high in the eurozone and the UK. Central banks need to look at their economies afresh and cut rates by at least 1, and ideally 2, percentage points.

Second, the only way to let the private sector deleverage, without mass bankruptcy and huge falls in spending, is by substituting the asset everybody wants: government debt. Contrary to Professor Sachs, I think tax cuts are indeed part of the solution.

Third, it is crucial that lending be sustained both inside and among economies. Having gone to such trouble to recapitalise banks, governments should insist that their money be used to sustain credit lines to those likely to remain solvent. If banks are unwilling to do this, central banks will have to replace them, as the Federal Reserve is now doing.

Fourth, it is in the vital self-interest of the affected high-income countries to keep hard-hit emerging economies afloat through the crisis.

Finally, it is equally evident that the world will not return to equilibrium if countries in strong financial positions do not expand domestic demand. The day of the housing bubbles and huge current account deficits in high-spending high-income countries is gone. Those who rely on current account surpluses to sustain demand must think again.

Decisions made over the next few months may well shape the world for a generation. At stake could be the legitimacy of the open market economy itself. Those who view liquidation of past excesses as the solution fail to understand the risks. The same is true of those dreaming of new global orders. Let us first get through the crisis. The danger remains huge and time is short.

* The Coming Global Stag-Deflation, October 25 2008, www.rgemonitor.com;** www.bankofengland.co.uk; *** The folly of the central banks of Europe, October 27 2008, www.voxeu.org
Copyright The Financial Times Limited 2008

A cure for the coming crisis in auto finance

By Spencer Abraham

Published: November 3 2008 12:37
Last updated: November 3 2008 12:37

The discussion in Washington about facilitating the merger of Chrysler and General Motors highlights the turmoil plaguing the US automobile sector. But there is also an emerging automotive finance crisis. The credit crash has triggered a precipitous decline in new car sales, caused in part by a rapid reduction in automotive financing. This in turn threatens to spark additional large write-downs in the financial sector. Rather than allow this systemic risk to spread through our entire economy, the Federal Reserve should move quickly to draw on past practice and create a conservative, well-established financing body that can bring relief to the auto finance sector, before it is too late.

The automotive industry is the largest manufacturing industry in the US. It accounts for an estimated 20 per cent of all US manufacturing gross domestic product, more than 1m jobs and an estimated 4m-6m additional jobs on an indirect basis. It is a cornerstone of the US economy.
EDITOR’S CHOICE

In depth: Auto crunch - Oct-29
US car sales sink to lowest level for 25 years - Nov-03
Daimler to make its first staff cuts in US - Nov-03
States urge Washington aid for carmakers - Oct-30
Analysis: The wheels come off - Oct-31
Editorial Comment: Why Detroit is not Wall Street - Oct-30

But the sector has been hammered by the freeze in the credit markets. Consumers are facing higher interest rates on loans and dealers cannot obtain the financing needed to purchase inventory. New vehicle sales plunged 23 per cent year-on-year in September and are forecasted to fall by approximately 30 per cent in October. Total sales this year are expected to be just 11m vehicles – the lowest level since 1983.

The fundamental issue is auto loans, or rather the absence of them, since 94 per cent of consumers finance their car purchases. Finance companies cannot sell or finance auto receivables in the wake of the worst financial crisis that the asset-backed securities market (ABS) has ever seen. That has left these companies with little choice but to curtail lending, which is contributing to the precipitous drop in car sales.

The double whammy of declines in lending and in car sales will deal another punishing blow to the already beleaguered auto sector and will create profound risks for the US financial system. Consider this: for the past decade, domestic automotive sales have averaged 16m-17m units per year and that translates in to the extension of approximately $375bn of auto financing each year. Given that the average life of an auto loan is 2 years, an estimated $700bn-$800bn of exposure is currently thrashing around our financial system.

This exposure exists in a variety of forms. Regional and national banks, as well as credit unions and finance companies, are holding these loans on their balance sheets. Banks also have exposure to auto financing through conduits, structured investment vehicles and collateralised debt obligations, whose value is tied to automotive loans or ABS. In recent years, annual issuance of these securities has approached $100bn. And in 2008 these securities have accounted for more than 25 per cent of all ABS (only the credit card sector has issued more). Insurance companies, mutual funds and pension funds alone are estimated to have $80bn of exposure and the banking sector’s exposure is in excess of $200bn.

But reduced auto financing deprives the financial sector of a massive revenue stream and will deliver another shock to our financial system.

Even worse, the pain will be intensified because the banks have not hedged their exposure to auto loans, given the absence of any benchmark index comparable to the asset-backed securities index, which is used for mortgage portfolios. While the causes of the problems facing the auto and real estate sectors are very different – the auto sector has not been hampered by sloppy underwriting standards, for example – the common denominator is that downturns in both sectors threaten the stability of the US economy.

Sounds pretty scary, and it is. But we have the ability to prevent the auto finance crisis from spinning out of control as has been the case with the sub-prime crisis. Allowing the Big Three’s finance companies to become bank holding companies on an expedited basis – a step that press reports indicate is under discussion – is an ideal solution. This would allow them to obtain funding from the myriad programmes established by the Treasury and Fed.

Another way would be for the Fed or Treasury to do what they have done before when restricted markets need financing – provide loans on a direct basis. Here is how it would work: allow troubled auto finance companies to establish a new entity, to which the Fed would provide debt capital that could be used to originate auto loans. In turn, this finance company would manage all new loans. Unlike the sloppy lending standards in the home mortgage industry, auto lenders tend to be much more conservative. The majority of the loans would have highly predictable performance characteristics. So government would be unlikely to sustain any significant losses and could actually earn a very healthy return on its capital.

By providing capital, the Fed would help auto companies increase their loan volume, which in turn would help them reduce their cash burn and would shrink the ultimate size of the riskier government guarantees needed by the Big Three to ensure their survival. The government would simply be serving its appropriate role as “lender of last resort,” against good collateral and in a manner that would be profitable to the taxpayers.

At a time when the US economy is coping with the fallout from a deeply depressed housing market and turmoil in the banking sector, the last thing it needs is another shock to the system in the form of a meltdown in the auto financing sector. The Federal Reserve, having been late to recognise the implications of the subprime mortgage fallout, now has an opportunity to redeem itself and take an important step toward restoring the stability to auto finance.

The writer was US secretary of energy from 2001 to 2005 and senator from Michigan from 1995 to 2001, during which time he was chairman of the Senate Subcommittee on Manufacturing and Competitiveness. He is currently chairman and chief executive of The Abraham Group, LLC

Haldane Society Lectures

HALDANE SOCIETY LECTURES2008 – 2009

Thursday 13 November 2008: Crisis for publicly funded legal services, June Venters QC and Laura Janes (Young Legal Aid Lawyers)

Thursday 11 December 2008: Challenging Arms Suppliers in the Courts; the Consequences of the Serious Fraud Office litigation

Thursday 29 January 2009: Northern Ireland Civil Rights Movement 40 years on, Richard Harvey and Eamon McCann (invited)

Thursday 19 February 2009: Human rights in civil law cases, Liz Davies and Louise ChristianThursday 12 March 2008: Human rights in criminal cases

Thursday 23 April 2008: Lawyers who go the extra mile, speaking out for their clients: Aamer Anwar and another.

All lectures at the College of Law, 14 Store Street, London WC2, 6.30pm – 8.30pm. Admission free (£10 charge to legal practitioners requiring CPD points).