27th September 2009 Single handed Gordon Brown has all but ruined England. His hatred of the English, his incessant greed for power, his insane fixation on getting re-elected at any cost, his fear of rivals and almost paranoid attempts to “fix” things in his favour, his willingness to lie, to Parliament and the country, in order to achieve his own selfish ends, his inability to see the wood for the trees in all he does, but most of all, his mismanagement of the economy and of the financial system, have made of him a political monster almost without peer in English history. Last month the government deficit was £16 billion – enough, in one month, to almost replace the Trident fleet. It is now running at an annual rate of £192 billion as against the Treasury figure of £175 billion. We live today in the biggest economic shambles of all time. Banks have £680 billion in toxic assets some 85% of the worst are likely end up in the governments Asset Protection Scheme causing some commentators to talk about a ‘massive fraud’ on the taxpayer Why did all this happen? It happened because Gordo allowed the mother-of-all credit booms in order to ensure his election to the premiership. It happened because the UK had the most globalised banking system, and hence the one most open to the worlds financial risks, It happened because we had the lightest touch, and probably the most dysfunctional, bank regulatory scheme going. Something urgent and something significant has got to be done. Don’t get me wrong. Commercial banks, the sort that lend to industry and consumers are absolutely vital to any economy. They give borrowers access to the savings of the nation in an orderly manner and their lending activities increase the supply of money in the economy, which as the early 19^th century English economist Ricardo said “Oils the wheels of industry”. Without commercial banks you cannot have an economy in England that would support 25 million people let alone the 50 million we have. But without a safe, regulated, commercial banking system you have an unstable economy. Mervyn King said in an interview some months ago that the regulators just did not have the tools they need to manage the situation. Why? It has been 233 years since the publication of the ’Wealth of Nations’ and 315 years since the founding of the Bank of England. So, why has this crisis occurred? Well for Mervyn and the ‘Heavenly Duo’ (they come from ‘up there’ after all) here is my Alphabet of key Bank Regulatory changes. A is for accountability. It is absolutely vital that the boards that run banks are held accountable, not just to their shareholders, but to the nation as well. They have in the US something called the Sarbanes-Oxley Act where by the CEOs and CFOs of businesses that falsely state they have an acceptable system of internal financial control which they have personally reviewed, can go to prison for up to 5 years and be fined up to $10 million. Notice that no business failure or fraud has to occur, only making a false statement. This is the minimum penalty that should be applied to the boards of banks and there should be no wiggle room. If the regulator decides the bank needs saving then this is prima facie evidence in court. B is for the Bank of England. It should be given the responsibility for regulating banks and other depositary institutions. The current system splits the responsibility 3 ways and has to go. B is also for Booms. The bank must be given responsibility for controlling booms just as it is does inflation.  The Bank controls the rate at which retail prices rise and it should also be able to control the rate at which a range of other asset prices rise such as housing. This is not just an idiosyncratic notion. We are attempting to control an economic and financial system. In the science that covers the control of systems there is Ashby’s law of Requisite Variety. Put simply this means that for each variety of activity in the system the system regulator must have an equal variety of responses. Financial and economic systems go through booms and busts, bubbles and crashes. If you do not control both you control nothing. C is for clarity. Without accurate information financial systems cannot work. We should no longer allow Banks and other institutions to create complex derivative products and then sell them privately so that no one knows what their exposure to the assets is and what the true risk is. C is also for capital. In the event banks were vastly undercapitalized. Capital requirements need to be changed and this in turn requires our understanding of risk to change. It is a technical matter but the world of mathematical finance has known since the PhD thesis of the French statistician Louis Bachelier in 1903 that current measure of risk underestimates the true risk by factors of 10 to 20! When Long Term Capital Management went bust in 1998 it complained of variations 25 times higher than normal. As a result banks are always chronically under capitalised. They will have to have more. Banks should have to take out insurance against running out of capital the premium for which will be proportional to their risk as well as size. Perhaps three Cs are too many but there is one more important one. Compensation. In return for being more closely regulated and accepting strict limits on compensation, commercial banks would not be open to criminal charges The boards of investment banks will be open to criminal charges and therefore the only controls should be on bonuses and a requirement to relate pay to long-term returns. D is for Division. We have to separate the commercial banks from the investment banks. In the UK our major commercial banks failed because they also had investment banking arms. Investment banking is by nature risky and we should never again allow the commercial banks, on which individuals and businesses rely to be brought down by investment banking activities. F is for Foreign Governments. There is a great deal of international competition to attract as big a financial sector as possible. Gordo in part made his reputation by the simple expedient of, in effect, saying to banks “Come here and do business and I will allow you to get away with whatever you want.” Part of the regulatory powers will need to be the ability to limit companies operating in England from getting finance from banks operating under a lighter touch regulation elsewhere, perhaps by imposing penalty tax rates directly on those borrowings. My final letter is L. L is for liquidity, that is the amount of cash held by the banks. In the year 2000 this was only 2% of sterling deposits and less than 1% for of sterling assets. This has to increase perhaps to 10% and banks will have to pay for their deposit insurance, with the premium related to their size and risk. My final prescription is L for Leadership. Currently the bankers are leading governments around by the nose. This has to be reversed. There are many other proposals that could be mentioned. We need to remember that we cannot get rid of booms and busts. But we can have a framework, that calms the boom, catches the bust before it becomes to big and puts the bankers that through their greed and negligence caused the problem, in prison.

27th September 2009

Single handed Gordon Brown has all but ruined England.

His hatred of the English, his incessant greed for power, his insane fixation on getting re-elected at any cost, his fear of rivals and almost paranoid attempts to “fix” things in his favour, his willingness to lie, to Parliament and the country, in order to achieve his own selfish ends, his inability to see the wood for the trees in all he does, but most of all, his mismanagement of the economy and of the financial system, have made of him a political monster almost without peer in English history.

Last month the government deficit was £16 billion – enough, in one month, to almost replace the Trident fleet. It is now running at an annual rate of £192 billion as against the Treasury figure of £175 billion.

We live today in the biggest economic shambles of all time.

Banks have £680 billion in toxic assets some 85% of the worst are likely end up in the governments Asset Protection Scheme causing some commentators to talk about a ‘massive fraud’ on the taxpayer

Why did all this happen?

It happened because Gordo allowed the mother-of-all credit booms in order to ensure his election to the premiership.

It happened because the UK had the most globalised banking system, and hence the one most open to the worlds financial risks,

It happened because we had the lightest touch, and probably the most dysfunctional, bank regulatory scheme going.

Something urgent and something significant has got to be done.

Don’t get me wrong. Commercial banks, the sort that lend to industry and consumers are absolutely vital to any economy.

They give borrowers access to the savings of the nation in an orderly manner and their lending activities increase the supply of money in the economy, which as the early 19^th century English economist Ricardo said “Oils the wheels of industry”. Without commercial banks you cannot have an economy in England that would support 25 million people let alone the 50 million we have.

But without a safe, regulated, commercial banking system you have an unstable economy. Mervyn King said in an interview some months ago that the regulators just did not have the tools they need to manage the situation.

Why? It has been 233 years since the publication of the ’Wealth of Nations’ and 315 years since the founding of the Bank of England.

So, why has this crisis occurred?

Well for Mervyn and the ‘Heavenly Duo’ (they come from ‘up there’ after all) here is my Alphabet of key Bank Regulatory changes.

A is for accountability. It is absolutely vital that the boards that run banks are held accountable, not just to their shareholders, but to the nation as well. They have in the US something called the Sarbanes-Oxley Act where by the CEOs and CFOs of businesses that falsely state they have an acceptable system of internal financial control which they have personally reviewed, can go to prison for up to 5 years and be fined up to $10 million. Notice that no business failure or fraud has to occur, only making a false statement.

This is the minimum penalty that should be applied to the boards of banks and there should be no wiggle room. If the regulator decides the bank needs saving then this is prima facie evidence in court.

B is for the Bank of England. It should be given the responsibility for regulating banks and other depositary institutions. The current system splits the responsibility 3 ways and has to go.

B is also for Booms. The bank must be given responsibility for controlling booms just as it is does inflation.  The Bank controls the rate at which retail prices rise and it should also be able to control the rate at which a range of other asset prices rise such as housing.

This is not just an idiosyncratic notion. We are attempting to control an economic and financial system. In the science that covers the control of systems there is Ashby’s law of Requisite Variety.

Put simply this means that for each variety of activity in the system the system regulator must have an equal variety of responses. Financial and economic systems go through booms and busts, bubbles and crashes. If you do not control both you control nothing.

C is for clarity. Without accurate information financial systems cannot work. We should no longer allow Banks and other institutions to create complex derivative products and then sell them privately so that no one knows what their exposure to the assets is and what the true risk is.

C is also for capital. In the event banks were vastly undercapitalized. Capital requirements need to be changed and this in turn requires our understanding of risk to change.

It is a technical matter but the world of mathematical finance has known since the PhD thesis of the French statistician Louis Bachelier in 1903 that current measure of risk underestimates the true risk by factors of 10 to 20! When Long Term Capital Management went bust in 1998 it complained of variations 25 times higher than normal. As a result banks are always chronically under capitalised. They will have to have more.

Banks should have to take out insurance against running out of capital the premium for which will be proportional to their risk as well as size.

Perhaps three Cs are too many but there is one more important one. Compensation. In return for being more closely regulated and accepting strict limits on compensation, commercial banks would not be open to criminal charges

The boards of investment banks will be open to criminal charges and therefore the only controls should be on bonuses and a requirement to relate pay to long-term returns.

D is for Division. We have to separate the commercial banks from the investment banks. In the UK our major commercial banks failed because they also had investment banking arms. Investment banking is by nature risky and we should never again allow the commercial banks, on which individuals and businesses rely to be brought down by investment banking activities.

F is for Foreign Governments. There is a great deal of international competition to attract as big a financial sector as possible.

Gordo in part made his reputation by the simple expedient of, in effect, saying to banks “Come here and do business and I will allow you to get away with whatever you want.”

Part of the regulatory powers will need to be the ability to limit companies operating in England from getting finance from banks operating under a lighter touch regulation elsewhere, perhaps by imposing penalty tax rates directly on those borrowings.

My final letter is L. L is for liquidity, that is the amount of cash held by the banks. In the year 2000 this was only 2% of sterling deposits and less than 1% for of sterling assets. This has to increase perhaps to 10% and banks will have to pay for their deposit insurance, with the premium related to their size and risk.

My final prescription is L for Leadership. Currently the bankers are leading governments around by the nose. This has to be reversed.

There are many other proposals that could be mentioned. We need to remember that we cannot get rid of booms and busts. But we can have a framework, that calms the boom, catches the bust before it becomes to big and puts the bankers that through their greed and negligence caused the problem, in prison.