The Elephant in the Room

Ann Pettifor has written an excellent article on the now little talked about levels of leverage in the UK financial sector (http://www.leftfootforward.org/2012/03/all-the-signs-are-there-for-another-credit-crunch/) which I would recommend to everybody.  I can’t disagree with any of the comments that she makes, but I do think that it leaves one important issue answered - what and who will fill the void left by the banks deserting lending to the productive sectors of the economy as they focus on sorting out their own issues.

History teaches us that humans are adaptive, and when something fails, however disastrously, that alternative solutions are found and better ways are developed.  Tomorrow morning I am attending the launch of the “Next Generation Finance Consortium”, which brings together a number of alternative business finance providers, especially in the nascent area of peer-2-peer finance provision.  Banks are fundamentally involved in a process of intermediation - borrowing from people with excess capital (i.e. taking in deposits), and then lending to those people who need capital.  Historically people have needed banks to provide this function as this has enabled risk to be spread and managed, but is this function becoming increasingly redundant, both because the banks themselves have changed from being conservative custodians of our deposits into financial traders and because improvements in technology allow us to be our own intermediary?

More to follow after tomorrow’s event.

Nick

Spain is the New Greece

As 25 of the 27 EU leaders signed up to the new “Fiscal Compact” (http://www.bbc.co.uk/news/world-europe-17230760) to try to prevent another crisis akin to that happening in Greece, and Greece itself sinks into further economic oblivion (http://www.bbc.co.uk/news/business-17238523), concerns about the “next Greece” have subsided from their peak.  When the European debt crisis first developed, Ireland and Portugal soon followed Greece down the bailout path and concerns were raised about both Spain and Italy, before the focus fell strongly on the latter.  Italy has seen its Prime Minister change and a degree of confidence return in its economic management.  This focus on Italy and the rapid deterioration of Greece’s situation has seen the eyes turn away from Spain, but is this where the biggest risk lies?

News today that Spain will miss its deficit reduction target by a massive margin (http://www.bbc.co.uk/news/business-17235179) - with a forecast deficit of 5.8% in 2012 compared with a target of 4.4%, a difference of over 30% - demonstrates how little progress it is making.  At a recent seminar I attended the speaker described the situation in Spain in stark terms  - “the Spanish are lying”.  The Spanish property market has collapsed, but the banks are hiding the pain.  They reposes houses, but rather than record them at their open market value, they show them at the value of the loan.  Many of the cajas (roughly equating to British building societies) only keep going on the back of funding from the European Central Bank, a significant proportion of which I understand they have used to prop up their failing pension funds, much to the disgust of Northern European central bankers.

Unemployment recently passed 5m (http://www.bbc.co.uk/news/world-16754600), equivalent to 22.8% of the working population, while youth (16-24 years old) unemployment has hit an eye-watering 48.6%.

Although Spain has a much greater industrial base than Greece, much of it world class, (Seat cars and a significant element of Airbus aircraft for example), so much of its economic effort in recent years has gone into one area: residential real estate.  While the building of houses is clearly a worthwhile activity, creating both employment and trade at the time of construction and homes for people to live in, when this activity turns speculative, it can become corrosive to the economy.  No longer primarily a place for people to live, it becomes instead an asset to buy in order to appreciate in value, despite not actually producing any economic activity once construction is complete.  Spain is now paying the price for this folly.  Just as in other countries such as the UK, USA and Ireland, appreciating house prices have given the Spanish people the illusion of rising prosperity, while the reality is one of rising debt levels rather than increasing trade, productivity or innovation.

The rising oil price could provide the straw to break the camel’s back.  Spain has no indigenous oil supplies and car ownership levels some 16% higher than the UK.

So, keep your eyes on Spain, I believe it could be an “interesting” few months ahead.

Nick

Local Mutual Savings Banks as Catalysts for Regeneration

Regeneration Model.pdf Download this file

I posted this last week but I understand that the file was difficult to access, so I am re-posting in a different way.

The linked file details a model for the use of local mutual savings banks as a catalyst for economic regeneration.  The model is based on legislation in the UK, so would need tweaking for other jurisdictions, but the principles have broader application.  The aim of this project is to build a framework around which a town or borough can build a local approach to financing and building job creating businesses in their locality.  It utilises existing legal structures and regulations, so requires no changes at a national level, but combines them in a creative way so the whole is greater than the sum of the parts. I would be interested in any feedback.

Nick

Why is employee ownership not more popular?

The University of Leeds published some research on employee owned businesses (http://bit.ly/xgnd77), highlighting their success, especially during the current economic difficulties.  It makes me ask the question as to why they are not more popular?  The logic for employee ownership is compelling; it clearly aligns the interests of capital and labour, so why so little take up?  I shall ponder this one further.....

Nick

Bankers' Bonuses - A Fairer Solution

The media, both conventional and newer social media, is full of hysteria about bankers’ bonuses right now, but nobody seems to be suggesting solutions beyond either the status quo or stop them completely; neither offers a satisfactory solution.  For me, the only solution for the future is to look to the past and who this problem was addressed successfully for many generations.

Until the deregulation of the 1980s, there was clear demarcation between commercial banking, i.e. deposit taking and using those funds to make loans to individuals and businesses, and investment banking, i.e. the issuing and trading of securities and associated advisory activities, at least as far as the major Anglo-Saxon economies (Continental Europe had followed a different path, but one with less active securities markets.)  Those involved in investment banking (the US variant) or merchant banking (the UK variant that added trade finance but removed securities market trading from the business mix) were traditionally organised as partnerships, (just as other professions such as lawyers and accountants) and even when they converted to limited liability companies, they retained the basic partnership concepts: those who ran the business, owned the business and they shared both the profits and the risks.

The last 30 years have seen a dramatic change to this model; the people actively engaged in the business generally have little ownership of the business, share significantly in the upside but run little risk beyond that of losing a job.  The capital is now largely provided by large financial conglomerates, often with commercial banking at their heart, with management who have little understanding of the investment banking business.  The financial crisis of 2008 added a very dangerous new development; for the first time investment banks found themselves beneficiaries of tax-payer funded bail-outs.

The Vickers Report in the UK has recommended the ring-fencing of UK commercial banking from investment banking and international operations, and this has been generally accepted by George Osborne.  My suggestion is to take this one stage further, and to an element return investment banking to a partnership type structure, albeit one that accepts the reality of larger capital basis than was feasible in the days of partnerships.

The “classic” financial model for investment banks was for revenues to be split three ways: staff, capital and other costs, but it only makes sense if the staff that earn the large elements of the revenue also participate in any downsides.  My model, which is based on the British legal system and the assumption that the investment bank is part of a larger financial conglomerate, is as follows:

• The investment banking activities are transferred into a limited liability partnership (“LLP”) where the existing owner (the financial conglomerate) is one member and the senior staff (the definition of which could relate to seniority and/or pay, but with the caveat that nobody could earn over £100,000 per annum unless they were a member of the LLP) at the investment bank are the other members.  
• The voting rights of the LLP would be 50% to the financial conglomerate and 50% to the working members (split on internally agreed percentages).
• The non-member staff would be paid salaries as normal, deducted, along with the costs of running the business before any profits were made.
• The financial conglomerate would receive the first “slice” of the profits, receiving an agreed percentage of the capital it contributes, say 5% over the Bank of England Base Rate, (5.5% at current levels).
• The remaining profits would then be split on the same proportions as voting rights, but with 50% of all profits being reinvested as member equity in order to grow the business.
• If the business made a loss, this would be reflected in no remuneration for the working members and a reduction in the value of their equity stakes in the business.

Using this model, the investment bankers would be encouraged to act as entrepreneurial business people, rather than short term traders.  In good years they would see their remuneration rise and their equity stake increase in value, with the opposite in bad years.  At the same time, the parent financial conglomerate would be insulated from the activities of the investment bank, making it much easier to separate in the case of a catastrophe, and provide a barrier to the issues of “moral hazard” that became prevalent at the time of the 2008 crash.  This model would truly reward success and punish failure.

Nick

Local Mutual Savings Banks as Catalysts for Regeneration

This is a research paper I have worked on that provides a model for local areas to create jobs and regenerate their economies. All comments welcome. http://bit.ly/xyNcGK

Nick Harriss @ Google+

Will @Crowdcube&@FundingCircle create a genuine alternative to banks? http://reut.rs/wTBV5E I think they'll have an Amazon/eBay like impact over the next decade, and as someone working in corporate finance, I'm certainly preparing for it.Small businesses seek crowds as funding alternative | ReutersLONDON (Reuters) - Just weeks before the birth of her first child, Gem Misa could be found handing out samples of her home-developed salad dressing range in a high-end London department store, an apro...

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