Tuesday 16 September 2008

City Life

I stopped working in a City dealing room in mid-2002; until this week I hadn't really missed it.

But the gradual yet persistent bursting of over-priced asset bubbles is fascinating to watch, and would probably be even more fascinating from the inside. A doubling and halving of the price of a major company (HBOS) more than once in an hour is a rare event. Of course it was silly, it bore no relation to underlying values, but it reflected extreme uncertainity. The old phrase no gain without pain is true in this regard: things can only get better once asset prices are low enough for people to have confidence to regroup. I suspect there is a long way to go but at least the process is underway.

I'm pleased one bank, Lehman, has been allowed to go under:
- Lax Government regulation and central bank policy was a major cause of the problems. But poor risk and business management by the major banks was just as important. So it’s good to see shareholders and to a lesser extent management lose;
- It shows Governments will not always bail out failing institutions, which will encourage more careful behaviour;
- The financial industry needs to understand credit risk: it needs to really understand what happens as all the interconnected deals unwind. A major trading bank has not failed for decades and no-one knows how it will all be dealt with. This failure let us see how things unwind, it will identify problems and let them be sorted them out. This transparency will be help build confidence.

The US has also decided to save some institutions – but in those cases it has also ensured top management changes and ensured a major loss for shareholders. And in addition, in all cases it has acted quickly; their equivalent of the Chancellor has taken a leading role and its Central Bank has been quick to cut interest rates (reflecting the risk of recession) and to add liquidity to ease day to day trading between banks.

I think this contrasts with the UK. The Bank of England was slow to put in place a scheme to help add liquidity to help banks trade with each other – it was months after the European Central Bank and the Fed in the US. And their scheme expires at the end of September. Yet at the start of this week – when Lehman had failed, when the biggest insurance company in the world was in deep trouble - they had not announced a replacement or a renewal of the scheme. No wonder questions about HBOS’s liquidity were raised. The Bank has now extended the scheme till January – Stable doors being shut?

And then interest rates in the UK have not been cut because of (valid) concerns over inflation. But the Bank of England has been constrained by two things:
- the massive increase in UK Government borrowing over the last 10 years; and
- the way the Bank of England’s monetary policy committee was established, with the responsibility to look at inflation only. In the US the Fed has a dual responsibility, to manage inflation while maintaining a stable economy. The UK approach worked while things were benign and is in danger of failing now.

And another time when the authorities were slow to act: Northern Rock. Certainly, Northern Rock’s disregard for risk management as it expanded wildly was its own fault but once the problems were exposed the Government was slow to act – it was always behind the curve and didn’t finally nationalise it for almost 6 months. A little slower than the US in the same position. One reason was the complex system of tripartite responsibilities for regulation set up by Gordon Brown at the start of his Chancellorship. Again, it worked when it didn’t have to, but fell short when it was needed.

I agree the problems were not initiated by this Government. But the UK’s position has been made worse because the Government coasted on a global asset price boom while borrowing excessively and establishing inadequate structures, with the resulting slow responses once problems emerged. It’s worrying our direction is in the hands of a Government that is so internally focussed and has laid such a poor base for recovery. I am sure the Conservatives are right to let Labour implode – but I also hope they are giving serious thought to what they would do if they do form a Government in terms of:

- Financial regulatory structure;
- Spending control; and perhaps most importantly
- Tax reform

1 comment:

Troy said...

In many ways the Conservatives are lucky to still have 18 months before they take over the reins of government. Time to sort out the questions you rightly raise. If dithering Gordon had gone to the electorate last year either the Conservatives would have inherited this present poison chalice or we might still be facing four more years of Labour.

I trust on your blog you will advise us when the time is right to "regroup" in the market.