Sunday, 7 February 2010
Old skool banking meant borrowing money from savers (e.g. via a savings account) then lending it onto borrowers (e.g. via overdraft facilities). In this way old skool banks were intermediaries that facilitated the transfer of cash between those wanting to save and those wanting to borrow. Even better old skool bankers did a time transmogrification thingy as well; because they knew there’d always be cash sloshing about in a mix of savings and current accounts (Mr A has made a withdrawal? Who cares Mrs B has just had her salary paid in), they could borrow short-term and lend long.
The obvious point here is that the volume of deposits a bank has determines how much cash it has to lend i.e. a small deposit base is a constraint. The discovery of wholesale funding bypassed this , most obviously at Northern Rock, which was able to lend oodles and oodles because around three-quarters of its funding came from wholesale markets rather than depositors.
In fact am sure I can remember seeing some graph produced in 2008/2009 that ranked every big financial institution in Britain by the % of funding they derived from wholesale sources. Northern Rock was the clear outlier, but as you looked at who was second, then third and fourth in line you realised you were looking at which banks (lets be honest, which former building society) would be the next to go under.
The moral of this is pretty clear – any bank reliant on wholesale funding shouldn’t be let near any part of the retail banking market. Except, I’m having difficulty squaring this with John Kay’s proposals for “narrow banking”.
Originally, in a paper what he wrote in September 2009 he defined “narrow banking” as follows: “Only narrow banks specialising in these activities could describe themselves as banks. Only narrow banks could take deposits from the general public (deposits of less than a minimum amount, say £50,000). Only narrow banks could access the principal payments systems (CHAPS or BACS), or qualify for deposit protection.
Narrow banks might (but need not) engage in consumer lending, lend on mortgage, and lend to businesses, but would not enjoy a monopoly of these functions.”
This to my mind is all well and good. Except, listening in to a half decent Radio 4 “Analysis” programme broadcast this month yer man Professor Kay appeared to have redefined his definition somewhat judging by the transcript: “Professor Kay believes that because so much has changed since the 1930s what’s needed now is a variation on the Glass-Steagal theme. He calls his version “narrow banking”. He would limit the activities of retail banks to the most basic banking functions; looking after your money and making sure the payment system works. Narrow banks would only invest in government bonds, and the government would guarantee their deposits in return.
KAY: Now what I would do would be establish retail banks that take deposits and access the payment system, but the business of providing even consumer credit and mortgages and small and medium size loans would be done by specialist lenders. And some of them I think would be standalone organisations and others would probably be parts of bigger financial holding companies, which would run narrow banks but would also provide a range of other services to retail customers.”
The killer point here for me is the comment “only invest in government bonds”. Like where has the financial intermediation between private savers and private borrowers gone? Does this mean narrow banks wouldn't sell mortgages, credit cards or personal loans? Like is narrow banking simply about hoovering up retail deposits to pass on to government?
That’s not necessarily a bad thing to be honest, given it potentially minimises the imprtance of selling sovereign debt into international markets and all the rating agency shite that entails. But, if “narrow banks” only engage in retail deposit taking, who is going to lend to private individuals (e.g. sell you a mortgage) and, more importantly, how will they fund it, via wholesale markets in a Northern Rock style? Am confused rather than critical if honest, but my take on the latest definition of a “narrow bank” is that it appears so tight as to engender unnecessary risks.
Saturday, 6 February 2010
A credit rating provides a measure of how likely a borrower is to be able to repay a loan; the lower the rating, the greater the risk, the higher the cost of borrowing *. Right now politicians and “experts” and what not across the world are looking to cut their respective government borrowing levels to preserve national credit ratings.
Take George Osborne for instance “maintaining the U.K.'s top-notch credit rating would not be easy but said it would be a central "benchmark" on which his party's economic management would be judged if it wins power this year … and pledged Tuesday that a Conservative Party government would hold onto the U.K.'s AAA credit rating,”
Now as a political strategy that is one top class bitch move cos it means you can blame someone else every time you cut public spending AND link it to the greater good.
Like when you does stuff like
- introduce a 3 year public sector pay freeze
- tighten eligibility for benefits (but not actual payment levels) to reduce spending
- cut capital spending on roads, schools, hospitals, social housing and what not
- hack back funding for “non-core” public services like libraries
- and so on and so on
All you need say, in a big boy done it and run away type voice, is something like “we are taking these TOUGH decisions to preserve Great Britain’s TRIPLE-A credit rating because of all the MAD/BAD shit Labour did. By doing this we will ………………………. (stop the cost of government borrowing increasing, except this last fundamental bit is usually too much to include in a soundbite. Plus it alludes to the creditors who are directly/indirectly dictating what a democratically elected government has to do in ways that will adversely affect lives).
Even better, if the rating is maintained, then depriving people of public services and decent pay can actually be presented as a good thing. Who cares if a growing number of auld yins are left sat for days in their own piss, our credit rating is still AAA!
With political debate now simply a question of what to cut, when and by how much, rating agencies are apparently defining the parameters and direction within which government sets its policies and budgets, regardless of whose prime minister **.
Except I once worked besides a bloke who’d worked in a rating agency and was an utter tosspot. Seriously, he used to spout inaccurate, inane, unrealistic, ignorant gibberish c.60% of the time, but only after forcing people to wait for him to gather his “thoughts” from a mind he claimed “was full of ideas”.
My painful personal experience might provide our potential future chancellor with a useful insight into the calibre of the rating agency staff setting a central benchmark with which to assess his performance. Or he might reflect upon how rating agencies used to think sub-prime was the bees knees. Such critique is also more constructive than the usual left-wing hide your head in the sand/anus approach of moaning about the inequities of globalised capitalism then passively accepting whatever it is you neither liked nor understood in the first place.
He might even consider the example of Japan. See, Japan had the same triple AAA credit rating we aspire to maintaining throughout the 1980s and 1990s. That’s lovely you might say, generous even, except the 1990s was what’s called Japan’s “lost decade” throughout which the economy did well when it managed to stagnate.
A major factor driving the Japanese economy into the doldrums was the aftermath of a cheap credit fuelled property bubble that’d been popped in 1991 (sound familiar?). Government and banks collectively thought that economic growth and a recovery in asset prices would sort things out so chose to sit and wait it out. This was a shame because land prices, fer instance, had actually started what turned out to be a 17 year decline that left bank balance sheets clogged up with bad loans they were unwilling to ‘fess up to or write down in the hope of an eventual recovery that never came.
All this was exacerbated by the keiretsu model of closely inter-linked clusters of banks and industrial concerns that characterises much of the Japanese economy. Now to get an insight into these links I mind some Japanese bloke I knew explaining how his grandad’s steel company had been invited to join a keiretsu and that to seal the deal, he was to marry a daughter of one of the bank executives involved. So with relations between keiretsu members close to the point of being incestuous, the mutual obligations these created saw banks tying up chunks of what remained of their assets/capital in even more non-performing loans to companies that would otherwise have been bankrupt without them (those outside a Keiretsu were of course treated less favourably).
Anyhoo, Japanese banks systematically under-reported their non-performing loans for years letting everyone pretend everything was A-OK. Except it wasn’t, bank balance sheets were so bunged up with dreck they had limited scope to do the new lending that would finances consumption and all that good stuff. Eventually, following a rash of bank failures, the government started fucking shit up from 1997/98 onwards; bailing out this bank, nationalising that one and capital injecting others. At the same time banks started to ‘fess up to all the shite they had on their books which meant mucho write-downs and more honest reporting that helped non-performing loans as a % of the total reach a cheeky peak of over 8% in 2002, before falling back on a sustained basis to under 2% by 2008.
All very interesting you might say give or take how come the rating agency fucktards didn't appear to have cottoned on to reality in the 1990s despite them being central benchmarks for and shapers of economic policy. And how do you explain the rating agency response to government efforts to resolve matters, which in 2001 and 2002 i.e. after the worst of of what had become a financial crisis was largely past, meant “penalizing the government of the world's second-largest economy for failing to curtail its fiscal deficit or revive its faltering economy” by repeatedly cutting its credit rating. (see also). See that strikes me as totally counter-intuitive that does, it’s like the rating agency policy was we don’t care if your entire 1990s are fucked, but don’t you dare ‘fess up to problems and try and sort them out or we'll do you ugly.
I asked some economist involved in producing country ratings about this the other day and he said it was to do with the levels of public debt government actions had created. I think this is pants. Instead, I think rather than their having been any great analysis or logic underpinning the rating agencies’ stance towards Japan, some rating agency fucktard kneejerked about the last 2 quarters’ government borrowing figures cos they were too thick to take into account the positive effects this would have; this was debt taken on to sort shit out after all. And ignoring the abso-fucking-horrendous moral hazard aspects of the ways in which Japanese banks were recapitalised, anyone with more than mucus up their arse for a brain can understand that debt-financed government spending can support the future economic growth that generates the tax revenues needed to repay borrowing.
So sure, sure you could try and come up with some justification based on some half-arsed neo-classical economic theory you vaguely remember from university as to why government debt beyond a certain level is a bad thing. Except the definition of acceptable government debt levels is largely arbitrary and its no as if any rating agency fucktard has the right data or skills to produce anything more than crude simulations that - give or take the self-fulfilling aspect of credit ratings where cutting a rating because of concerns about a government’s ability to repay/service its debt makes it less able to repay/service its debt - say fuck all about fuck all. In fact as someone who has seen credit rating models produced by internationally reknowned "experts" used in anger then described by their actual users as random number generators, I can truthfully say credit ratings often say less than fuck all.
Then there are the perverse incentives credit ratings create. In the Japanese case this was potentially to not do anything about its banks. With sub-prime it was more straight forward - it was about precisely designing asset backed securities that ticked all the right rating agency boxes to get rated triple A, but turned out to pose horrendous risk. Closer to home it’s the accounting trick that is PFI/PPP, which is primarily designed to do no more than keep the debt associated with government capital spending out of the national accounts rating agencies use to assess Britain’s credit rating.
So anyway, that’s my reasons for saying rating agencies are fucktards and by implication anyone wanting to use their output as a basis for benchmarking their performance a total fuck-nugget. Personally, I've no idea why rating agency finances, incentives, models, criteria, accuracy and competency aren’t subject to systematic, routine and in-depth public scrutiny, challenge and review, especially given the sub-prime catastrophe. Its time we started to do them ugly.
* That’s the theory, the reality when it comes to say mortgages before and after August 2007 is rather different.
** You could say its actually the people buying the government debt that are the issue. But, as credit ratings determine the price of said debt and the buyers are heavily reliant on the rating agency assessments, you'd be missing the point.