Thursday, 23 December 2010

Christmas Special

Here's a little thought to distract you from the frustration of seemingly insufferable transport delays over the holiday season: might all this grief be a signal to either buy transport companies' shares or short them?

If it's true (as you may bitterly begin to suspect) that transport companies are ultimately profiting from captive UK customers (and the government) by raising fares despite ongoing public subsidy, under-investing in service improvement or snow-clearing and/or saving money by reducing services during difficult weather conditions, then might it not be worthwhile to buy their shares? I mean, if they're engaging in all theses tactics to be more profitable, then why not climb aboard?

Or perhaps you would prefer to bet that, if transport companies are unfairly taking advantage, then sooner or later they'll get rumbled and their stock prices will fall. In which case it may be worth shorting their shares.

In either case, any gains you might make would at least off-set fare increases and other costs. And the consolation that you are personally profiting from disruption might ease your personal discomfort.

Of course, your suspicions may prove to be unfounded or, even if true, may not be material to corporate results or otherwise sound in the market. In which case your investment won't pay off and you're misery may increase. But, hey, at least you'll be able to console yourself that you didn't just sit there simmering helplessly ;-).

Anyhow, safe travels and have a happy Christmas and New Year.

Image from ImpactLab.

Tuesday, 21 December 2010

German 'Fraudclosure' Issues

Hat-tip to Glen Davis, insolvency and financial services barrister par excellence, for pointing out Dr Philiipp Esser's piece on "Mortgage Foreclosure Turbulence" in Germany.

It seems the US securitisation market is not the only one in which the purchasers of mortgage debt have enforcement problems. German portfolios are similarly vulnerable.

According to Philipp, the Federal Court of Justice of Germany (Bundesgerichtshof, BGH) has ruled (in XI ZR 200/09) that the Risk Limitation Act 2008 requires the loan purchaser to become a party to the original security agreement between the borrower and the original lender before it can lawfully exercise any immediate right of foreclosure in that security agreement. Merely taking an assignment of the agreement from the original lender is not enough. Unlawfully foreclosing will also render the loan purchaser directly liable for any damage suffered by the borrower.

Philipp suggests that "in most transfers of real estate loans for purposes of refinancing the acquirer has not joined the [original] security agreement."

Robo-signers beware!

Friday, 17 December 2010

Policy Fail? Simple Products And The UK Treasury

The UK's regulated financial services providers have failed to co-operate with various government initiatives to encourage the offering of simple financial products, according to a recent report by Professor James Devlin for the UK Treasury. He found that:
"The combination of a relatively low fee cap [1 to 1.5%], free movement in and out of products without penalty and the relatively low level of funds invested by many users together represented a formidable barrier to enthusiasm from the industry for previous “simple products” (Devlin, p.4)
The lack of simple regulated financial products affects virtually the entire UK population. The primary target may be those people earning low to medium incomes, and those with little financial services experience/expertise/interest and/or limited savings (Devlin, p.10). But people earning higher incomes (over £30k) include themselves in the target market because they would most welcome "standards which show when a financial service offers customers a reasonable deal" (Devlin, p.14). The Treasury also notes in the accompanying consultation on simple financial products, that 48% of UK households have less than a month's salary in savings, and 27% have none at all (para 2.13).

When launching the Retail Distribution Review of financial advice in 2006, the FSA claimed that "insufficient consumer trust and confidence in the products and services supplied by the market lie at the root of what we are seeking to address." And while Professor Devlin cites recent research to the effect that trust in financial service providers is "not significantly below" supermarkets, mobile phone providers and the NHS (Devlin, p.16), that's not saying very much. Investments, pensions and securities are the least trusted consumer services across the EU. Only 34% of consumers think they deliver what's promised, 26% of us are as likely to trust investment providers as used car salesmen, yet 76% of us don't bother to switch providers. What would be the point?

Faced with regulated financial services providers' continuing refusal to supply suitable investment, pension and savings products at reasonable prices, you'd think the government would directly question the structure of all the providers and their products. After all, similar proposals for 'vanilla products' are afoot in the US (and meeting strong resistance from providers, of course (Devlin, p.31)). Instead, however, the UK government has meekly decided to avoid simple investments altogether and focus solely on simplifying "deposit savings accounts" and income protection insurance:
"Although the Government believes that the principles of simple products are widely applicable, it also believes that, initially, simple products should focus on products that do not carry risk to capital, i.e. that are not investment products. Risk would add an extra level of complexity to the product design, as the design would have to weigh up how much risk individuals are willing to bear, both in terms of capital risk and risk to gains."

This astonishingly narrow focus fails on at least four counts. First, and most obviously, it shies away from the key challenge facing the consumer: the lack of simple investment products. Second, it means the government won't enable us to diversify at a reasonable cost. Third, it encourages us all to put our money in the banks for little or no interest, leaving us exposed to inflation that continues to hover well above base rates. Fourth, given the banks' reluctance to lend their deposits due to capital constraints, these proposals inhibit the efficient allocation of our surplus cash to creditworthy people and businesses.

While initiatives to improve financial advice are helpful, good advice does not equate to simple products. The glacial Retail Distribution Review, launched in 2006, will only alter compensation for financial advisers from the end of 2012. Full advice will be fee-based and beyond most people. While advisers are "considering" developing a simplified advice model that might provide a "limited sales route", they're worried that if the investments do not perform customers may claim they thought they were given full advice which proved to be wrong (Devlin, p.26). I wonder why?!

In response to the sound of dragging feet, the government recently commissioned the Consumer Financial Education Body to develop a "free and impartial national advice service":
"It will not give regulated advice, but it will provide people with information and advice on all major areas of money and personal finance. A key component of the national financial advice service will be a financial healthcheck, that will provide people with a holistic review of their finances, highlight areas to prioritise, and give people a personalised action plan to take forward. The service will move as close to the regulatory boundary as possible to ensure that people have a seamless journey between the national financial advice service and regulated advice, should they need it. To this end, CFEB is exploring the possibility of providing generic product recommendations, for example 'you should consider purchasing home contents insurance'." (HMT, para 4.3; see also Devlin, p.29))
You mean home contents insurance is an investment? In what, burglaries?

That little gem aside, the "Moneymadeclear" web site may help improve the knowledge of someone who already has a basic understanding of the various types of financial service. But it won't help anyone to actually decide on a suitable product, or render products 'simple'. Which is surely the point.

A little sunlight may penetrate via the "key investor information document" introduced at EU level to enable easier comparison of the key terms of multiple products. Professor Devlin also suggests that strong warnings on products that do not meet "simple product" criteria (Devlin, p.5) and a traffic light system to declare the risk associated with products (Devlin, p.27) would help people choose suitable products. He has urged the government to retain rule RU64 that obliges a financial advisor to explain why any alternative product being recommended is at least as suitable as a simple product. He found that this rule led product providers to reduce fees for more complex products to make them at least as suitable (Devlin, p.22).

For now, however, we're stuck with expensive, complex regulated financial products.

Like... the Kickout bond! ;-)

Wednesday, 15 December 2010

Regulators Ignore Innovations In Lending

Politicians obfuscate by blaming banks for not lending, while insisting banks must conserve capital. Lord Myners has even U-turned into believing it's a good idea to split up the banks in order to create more banks, believing this will mean more competition.

But it's tough to see why more high street banks will mean more competition to provide unsecured loans to people and small businesses, given they're all bound by the same capital rules. We had lots of banks, and they had to consolidate to solve their capital problems. Metro Bank is said to be expanding rapidly, raising more cash to buy old bank branches others have been forced to sell for competition law reasons. But I don't see any truly disruptive difference between them and the other high street operators.

There's also a bigger problem here, as suggested by the finding in the latest British Social Attitudes Survey that only 19% of us think the banks are run well, down from 90% in 1983 and 60% in 1994.

Surely these circumstances demand a new regulatory framework for efficiently directing deposits to where they are needed most. Yet the existing framework prevents regulators from spending any time on this problem. Zopa's request for peer-to-peer lending to be included within the regulatory framework has not produced any joy, even though such platforms enable lending that doesn't tie up a bank's balance sheet and unlent funds remain in the banking system as commercial deposits. Loan volumes at Zopa have exceeded £100 million - 1% of the personal loan market - at a default rate of only 0.7%. Ironically, these numbers do not represent the sort of risk to consumers or the financial system that is claimed to command regulatory attention (which is itself debatable, given the lack of timely attention to the problems in the securitisation market).

In other words, if you have a highly capital-efficient financial innovation that represents a great deal for consumers, expect policy-makers and regulators to ignore you.

You're better off developing Kick-out bonds.

Image from Good Design.

Tuesday, 14 December 2010

Aged 30 To 34?

Yesterday the National Centre for Social Research published its British Social Attitudes report. More on that later. But I did notice the finding that:
"Those aged between 18-29 years old are more likely to feel discriminated against than any other age group, and are viewed more negatively than older people."

So I guess if your aged 30-34, you're golden.

Friday, 10 December 2010

WikiChill: Might Ain't Right

I can't decide which set of DDoS attacks are more mis-guided or counter-productive. Whoever is trying to 'take down' WikiLeaks may as well be jousting at clouds; and those attacking the global payments and cloud computing infrastructure may as well be... well, jousting at clouds. In fact, it's just cloud versus cloud, and both are only succeeding in making innocent crowds angry.

Somewhere in the middle of the WikiLeaks phenomenon is a discussion worth having. But that discussion can't occur while spooks and hackers - the masters of mystery and anonymity - remain the key protagonists, and self-important politicians embark on an arms race of overreaction.

Officials: let the leak thing play out. If WikiLeaks didn't exist, you would have invented it. Focus on changing your protocols to avoid what you really can't cope with. Adopt a decent email policy.

Hackers: focus your energies on inventing something distributed yet productive that will advance the cause of humanity. WikiLeaks does not need your help.

Image from PhysicsBuzz/Wired.

Thursday, 9 December 2010

Who Warned Whom About Madoff?

As noted by FTAlphaville, a fascinating aspect to the Madoff Trustee's case against HSBC is that accountants KPMG were asked by the bank to investigate Madoff's operation twice, and issued a damning report on both occasions, in 2006 and 2008 respectively.

This adds to the evidence that suggests Madoff's Ponzi scheme was quite a poorly kept secret from about 2000. Harry Markopolos said it took him four hours to spot the Ponzi scheme in 2000, using publicly available documents. Michael Ocrant published an article after a series of interviews in 2001, as did Barrons (see paras 215-220 of the Trustee's Amended Complaint against HSBC). And according to the Telegraph, Goldman Sachs banned its asset management and brokering divisions from dealing with Madoff's funds about the same time, while "a raft of blue-chip financial institutions have suspected something was wrong for years."

As the Trustee's cases unfold, it will be interesting to discover how far and how fast word spread, and who warned whom.

But the big question is why supposedly sophisticated financial institutions appeared to ignore the warnings? The Trustee claims certain activity occurred with the "intent to hinder, delay, or defraud creditors". But why? He cites the desire for fee income (at para 16). Perhaps the banks and other intermediaries may also have thought that all was fine, so long as their more valued clients got their 'magic' returns paid or their principal out, regardless of the fact that the money came from other participants. They may also have concluded, however unwisely, that it was too late to let go of a balloon that had risen to such lofty heights, and their best chance of recovering their more valued clients' funds was to risk putting more in... If that's the case, then the business of working out where those new funds came from must have been very bloody indeed. Note the Trustee's allegations (at para's 146-148) that Madoff's involvement was deliberately kept out of the 'feeder fund' promotional documentation.


Yet, as is apparent from "Fooling Some of the People All of the Time", investors can remain in denial even in the face of the most dogged attempts to convince them they're being foolish.

Wednesday, 8 December 2010

WikiLeaks: A Hard Case. Expect Bad Law

Given the enthusiasm with which numerous governments have attempted to thwart WikiLeaks, and their lack of a ready legal basis for doing so, we should keep an eye out for some exceptionally bad legislation.

We cannot expect the politicians to do nothing about this. There is just too much irony involved.

I mean, how galling must it be to claim the Internet is 'lawless' and then find that global commercial service providers seem to have no trouble enforcing their own cross-border terms of service?

And how can one now lay claim to being "diplomatic" when everyone's seen how much care diplomats take when writing to each other?

Never mind that "WikiLeaks" is just a brand name, and the material it publishes has already been leaked by... government officials.

But wait! There's hope yet. I reckon there's a line of official thought that might run something like this:
"We can't possibly have a law that specifically prevents official leaks. How would opposition parties ever get elected? It would be the end of democracy!

Well what about a law approving leaks in certain circumstances, like when they promote democracy? And let's not just make it a national phenomenon. Let's do it by international treaty. We could set up a single, not-for-profit organisation, not controlled by any national government, that would have as its charter the publication of leaked government information that it judges to be in the public interest. All officials could then simply disclose their leaks to it, and impartial editors from around the world could approve disclosure.

We could call it, "WikiLeaks"!"

Image from ThoughtTheater.

Tuesday, 7 December 2010

The Magic Of Madoff

Ever since the news broke that Bernie had made off with his investors' money (did you see what I did there?), I've been waiting for the forensic accounts of what happened. Well here they are.

Because US courts tolerate relatively florid language in their pleading, these court filings do not disappoint in their sense of outrage. The case against HSBC is the juiciest, complete with a 'smoking gun' email from February 2006 (at para 20 of the Amended Complaint), largely redacted, in which certain unnamed officials reacted to almost a full alphabet of "red flags" (listed at para 18) with the immortal refrain:
"It's the magic of Madoff."
In summary, the trustee alleges that:
"21. Ultimately, as custodians and administrators, the HSBC Defendants oversaw the infusion of no less than $8.9 billion into [Bernard L. Madoff Investment Securities LLC (“BLMIS”)'s fraudulent investment advisory business] through a network of feeder funds. The HSBC Defendants funneled even more money into BLMIS in connection with derivative structured financial products that they issued and sold to their customers.

22. For their efforts, the Defendants received billions of dollars to which they are not entitled. Many of these Defendants received tens, if not hundreds, of millions of dollars by selling, marketing, lending to, and investing in financial instruments designed to substantially assist Madoff by pumping money into BLMIS and prolonging the Ponzi scheme."
Now I can't wait for the hearing - and the movie!

Image from The Memphis Flyer.

Monday, 6 December 2010

Snake Oil And The "Science" Of Liberty

A hat-tip to @rorysutherland, who drew my attention to a paper called "The Science of Liberty" by Paul Zak, self-styled "founder in the field of neuroeconomics" with the following tweet on 1 December :
" expect to hear a lot more about Oxytocin in marketing writings going forward. This is a good piece."
The paper purports to provide a basis for lighter financial regulation, but ironically points in the opposite direction. It was funded in part by the John Templeton Foundation, a conservative philanthropic organisation, whose President also supports "Let Freedom Ring", the lobbying outfit that also supports the "Tea Party"; and partly by the Gruter Institute for Law and Behavioural Research.

I hope I don't do Paul's reasoning any injustice, but I understand his thesis to be as follows (italics are mine):
  • His research found that "a brain chemical called oxytocin (ox-ee-TOE-sin) is released when a stranger takes money from his or her pocket and intentionally gives it to another person in order to demonstrate trust tangibly... the more money the person receiving the trust-denoting transfer receives, the more his or her brain releases oxytocin. Oxytocin levels, in turn, predict how much the second person will reciprocate the first person; that his, how trustworthy she or he will be."
  • This process is "nearly impossible to inhibit".
  • However, 2% of those studied did not reciprocate, and "there is a technical word in my lab for these folks: "bastards (sic). Not people you want to have a coffee with... On the other hand, two percent isn't bad. It means most people most of the time are trustworthy, and the others can be identified with a slight bit of investigation."
  • Participants go out of their way to punish moral violations in the market "when observers of ethical violations are in a position to punish the violators".
  • As a result of these findings, Paul argues that "virtue is in fact the very foundation of trade... The market can be fabulously large if most people, most of the time, behave morally, and if their moral tendencies are supported by a legal system in which property rights are protected and contracts enforced."
  • Accordingly, Paul asserts that "Economic systems that provide for freedom and limited oversight recognize human dignity and the desire for self-direction."  Such "economies are complex, adaptive, and evolving systems that need no controller. Just a clear set of rules that are enforced by some independent regulatory body."
  • "A number of studies have shown that too much oversight crowds out our innate sense of virtue (Gneezy and Rustichini, 2000). A fine for every violation decouples transgressions from the moral violations to a "greed is good" justification. This is Enron and the like" [includes Ford (Pinto gas tanks) and USSR].
  • In other words, the Enron scandal was created by overly intrusive regulation, and therefore we should have less of it.
Certainly at this last point the logical elastic band finally snaps.

Ironically, far from presenting a basis for lighter financial regulation, I'm afraid Paul Zak's research into the effects of Oxytocin shows exactly why people need greater protection from the snake oil salesmen, who understand it's effects only too well. The "bastards" are out there, and even two percent of the population means there are actually a lot of them. They can be tough to challenge, especially once they've generated a bandwagon effect. And other market participants are not always in a position to punish these rogues, at least not in time to prevent them doing significant harm - due diligence does not scale well. Finally, Alan Greenspan, former Chairman of the US Federal Reserve advocated light touch financial regulation for 40 years, and lived to regret it:
"In Congressional testimony on October 23, 2008, Greenspan acknowledged that he was "partially" wrong in opposing regulation and stated "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity — myself especially — are in a state of shocked disbelief." Referring to his free-market ideology, Greenspan said: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.” Rep. Henry Waxman (D-CA) then pressed him to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Waxman said. “Absolutely, precisely,” Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.” Greenspan admitted fault in opposing regulation of derivatives and acknowledged that financial institutions didn't protect shareholders and investments as well as he expected."
"...[T]the unvarnished invisible hand story, although right in a fundamental way, is wrong at the level of detail and approximation that is necessary to explain what we need to know about macroeconomics.

The old story about capitalism is correct: it gives us what we think we want. But capitalism does not act as its own policeman if we fail to watch over it and give it proper directions. It actively, competitively, seeks the most profit-maximising opportunities. Capitalism will follow such opportunities wherever they lead us...

If [we] are willing to pay for real medicine, it will produce real medicine. But if [we] are also willing to pay for snake oil, it will produce snake oil. Indeed, nineteenth century America had a whole industry devoted to fraudulent patent medicine."
Now, I'm no fan of the Nanny State. I don't believe regulation acts as a market catalyst. And I've written often in support of better regulation rather than simply more of it. It's also clear that the financial regulation spawned by the accounting scandals like Enron failed to avert the latest financial crisis, and is unlikely to avert the next without a fundamental change in the importance that we attach to wealth creation.

But this paper perhaps may serve as further evidence that regulation should be aimed at improving transparency at the point when people first engage with a financial service or its promoter. Simplifying products, documentation and disclosures is critical. Another tactic may be to move away from vertical to horizontal models for intermediation.

More limited oversight is not an option.

Saturday, 4 December 2010

Relaxing The Rules: Swinegate Returns

The good citizens of Wales must be very afraid.

"During my election campaign, someone came up to me and shouted 'Thief!' and if I had been a man I would have run after him and punched him in the face.”
So Ann clearly reckons it would have been okay for ex-MP David Chaytor to lamp his outraged constituents - at least, presumably before this week's guilty plea - and now the Equality Strategy means there's nothing to stop her 'aving a go...

I empathise with MPs who say they are struggling with legislation that they misconceived in their haste to get re-elected. Really I do. Because you could say that about an awful lot of their output, including their appalling attack on the digital economy in the course of the infamous "wash-up".

But we soldier on without being entitled to run people down in the street and punch them in the face, and so must our MPs - male or female.

There must be limits to the extent MPs can relax the rules for themselves.

Friday, 3 December 2010

Where Will Your Tax Money Go? China?

Here is a fabulous tool to show how the UK Government spends our money. Here is a calculator showing where your own personal tax money goes. And, here is a forum to answer your burning questions around low cost government, waste and efficiency. These are all being developed in the course of the Open Knowledge Foundation's excellent Where Does My Money Go? project.

The forum has already settled a burning question of mine:
"What proportion of government revenue comes from personal income tax, as opposed to corporation tax?"
Answer: In 2008/09, the UK government collected £41.8bn in corporation tax and £149.6bn in income tax.

Together, we and the corporations paid about another £180bn in National Insurance (which of course corporations also pay for employing us) and VAT.

The government recently decided to lower the top-line corporate tax rate from 28% to 24%, and there have been protests about how large UK-based corporations like Vodafone minimise their tax. But I don't really begrudge them that. We need to incentivise private sector corporations to start here, and stay here to employ people and otherwise generate income.

I'm more concerned about how to incentivise ourselves. Corporations tax is a sideshow, compared to the fact that we individual taxpayers, who are effectively banned from incorporating, are supposed to aspire to pouring over 50% of our income into a leaky old public sector bucket - and then fund our own education, healthcare and "retirement" to the very considerable extent that the state cannot be relied upon.

The reason the economy struggles to grow is down to the horrific reality that over half of the country's economic output - and of our personal income - goes to support the public sector, which produces absolutely nothing. Civil servants should not feel slighted by that. As taxpayers they are in the private sector with the rest of us. And they have every right to feel just as alarmed as everyone else, if not more so - especially if they are sitting at a desk doing a non-job. Civil servants are citizens who are being overtaxed to pay for their own net incomes. Weird, huh?

Is this supposed to motivate each of us personally to stay in the UK and generate economic growth? Or is our declining share of income better spent on moving the family to, say, Hong Kong - or, indeed, to Singapore or China, as Jaguar advises, where people save half their income?

The reason that the current government's plans for how to stimulate growth are thin is because the government can't grow the economy. Only the private sector produces growth (though of course the government can be supportive... or not).

This coalition government can't and won't explain all this clearly, partly because it wants our taxes to keep rolling in so it can reduce the deficit in time for the next election, and partly because the Liberal Democrats in the ranks are almost as wedded to 'tax and spend' as their cousins in the Labour Party. Those people think that cutting taxes is "taking money out of the economy". But, of course, lower taxes merely leaves money in the hands of individuals - the private sector of the economy - where the public sector can't get at it.

Here's a growth hypothesis for you: If low income earners were to pay no tax, and others no more than 20% personal income tax/National Insurance plus 10% of income to a UK sovereign wealth fund that invested the money long term; and the administration functions in the public sector were halved, the UK would be growing faster by the next general election than under the current plan.


Image from Joystiq's coverage of tax relief campaign for UK games developers.

Thursday, 2 December 2010

Anatomy Of A Dodgy AAA Rating?

Can't wait for a judgment in Cassa di Risparmio della Repubblica di San Marino SpA v. Barclays Bank Plc (Case No. 08-757, High Court, Queen’s Bench Division).

According to Bloomberg, CRSM claims that "Barclays Plc deliberately designed structured notes that would have a much higher risk of default than their triple-A rating suggested" - i.e. "25% or more" instead of “a fraction of 1 percent.”

With any luck, the case won't settle, and we'll have some more forensic insight into the relationship between investment banks and ratings agencies, as well as due diligence and the ratings methodologies...

Wednesday, 1 December 2010

Lifting The Lid On The EU's Finances

Even putting fraud and waste aside, it's hard to understand how this approach is sustainable if Greece, Ireland, Portugal and Spain are anything to go by. Public sector largesse eventually seems to generate the need for public bail-outs, especially when local governments borrow to match the free money that's available. No wonder the new UK government has put an end to direct local authority funding through this mechanism.

Certainly all this porkbarrelling has done little for 'cohesion'. A recent poll found that only 42% of Europeans trust the European Union - reflecting a general disenchantment with EU institutions over the past few decades.

The seven year budget cycle and lack of provision for returning unspent funds to donor states also makes the scheme incapable of flexing to meet changing economic circumstances. The fact that a large proportion of this money is lying around simply unclaimed in the current environment is scandalous, and another blow to economic confidence.

It's a travesty that this money was raised in national taxes in the first place, let alone handed over to Brussels on the terms of this scheme.

The EU's budget for this nonsense should be slashed next time around.

Image from Forest's Fine Foods.

Tuesday, 30 November 2010

Hey Eric: Lend Your Euros Directly To Other People

Like previous financial crises, this one won't end until individual and collective confidence in banks and the financial system is restored. And while it's all very well for the Eurozone's political masters to be demonstrating their 'political will' to hold the Eurozone together at individual taxpayers' expense, their latest attempt at restoring confidence has not exactly impressed Spain's debtors...

But such bail-out headlines merely the typically dominant institutional narrative. The real question is whether the Euro and EU institutions actually have the confidence of EU citizens - especially taxpayers. A recent poll suggests they do not: only 42% of Europeans trust the European Union - reflecting a general disenchantment with EU institutions over the past few decades. Meanwhile, in sharp contrast, bottom-up facilitators that enable citizens to participate in shaping and personalising their own services have done very well.

This is reflected in the behaviour of EU citizens on the economic front. The implications of the one-size-fits-all Eurozone monetary policy seem to be regarded as just as unfair by German taxpayers and the French savers supporting Eric Cantona's suggestion for mass bank-withdrawals on 7 December as by those hitting the streets of Greece and Ireland. The Guardian quotes Valérie Ohannesian, of the French Banking Federation, as saying Cantona's appeal is "stupid in every sense". Yet, crucially, she did not explain why people should feel more confident about leaving their money on deposit, or why it is fair that banks receive taxpayer bail-outs while taxes increase and spending is cut. In the absence of any other narrative, each bail-out undermines our confidence even further, to the point where we hit the streets and seriously consider suggestions like Eric Cantona's.

But it doesn't have to be this way. There is a bottom-up narrative emerging, and our politicians need to focus on it.

Eric Cantona's confident call for mass withdrawals hints at the fact that people are prepared to put their money where their mouth is. But it would be futile for those with surplus cash languishing in low interest savings accounts to withdraw it all and hide it under their beds. Instead, they should join those who already put their money to work helping others, by lending it directly on peer-to-peer lending platforms to creditworthy people and businesses at a decent rate that also represents a decent return.

Sunday, 28 November 2010

Swiss Tailwind For Personal & Small Business Social Finance

Banks will find it more costly and less profitable to offer short term unsecured personal and small business finance under Basel III rules, according to a recent McKinsey report.

To comply with the new rules, Banks face a long review of their businesses and products to reduce risk, use capital more efficiently and minimise the need for market funding by the end of 2012.

Which is more great news for participants in the 'capital light' social finance business models, like Zopa and Funding Circle in the UK.

As I mentioned in the context of the proposals to regulate vertical shadow banking functions, people using these 'horizontal intermediaries' benefit from:
  1. Loan amounts being split into small one-to-one loans at inception, rather than having to wait for the slicing, re-packaging and grading involved in asset-backed securitisation;
  2. A direct, one-to-one legal relationship between borrower and lender for the life of the loan, enabling better control over debt adjustment and collection, where that becomes necesary;
  3. Lenders retaining day-to-day control of the management of their money and credit risk, minimising the capital required by the intemediary;
  4. The intermediary not needing to slice and re-package debt to alter loan maturities, since lenders can manage this by assigning loans of unwanted duration to other lenders;
  5. The intermediary having no balance sheet risk, and therefore no temptation to engage in expensive and complex regulatory, tax or other arbitrage;
  6. Transparency in the original underwriting decision and loan performance against grade - making lenders' due diligence easy, and removing the moral hazard of the kind we see in vertical intermediation models, where the endless slicing and re-packaging makes due diligence hard.
For these reasons, one might expect banks to allow their depositors to lend directly to their personal loan and small business customers. But it seems unlikely the banks could feed themselves on the scale of fees their nimble competitors can afford to charge. And they would soon face calls to allow the peer-to-peer approach for mortgages and larger corporate loans - by which time other nimble providers may well beat them to those segments too...

Image from

Friday, 26 November 2010

Usual Suspects Bottom Out EU Consumer Scoreboard

You may wonder why a blog focused on how we seize control of our consumer experiences devotes so much space to our frustration in the personal finance space.

Because, as the latest edition of the EC's Consumer Markets Scoreboard confirms, it's our biggest source of angst.

Bank current accounts and credit products, investments, pensions and securities all feature in the bottom 20% of the "Market Performance Indicator", with investments, pensions and securities coming in lucky last.

Real estate services, internet service provision and railways also get a pasting; as well as secondhand cars, clothing and footwear, meat, and house maintenance/ improvement goods.

An incredible 31% of consumers find it fairly easy to compare investments, although only 34% of consumers think they deliver what's promised. A naive 26% of us are as likely to trust investment providers as used car salesmen.

Yet 76% of us don't bother to switch providers...

As a result, until the usual suspects get their act together, we face an endless stream of edicts emanating from the Brussels bureaucrats, adding more and more to the complexity for both providers and consumers alike. A great deal more proactive work in this area by providers may help stem this tide. Switching providers might also help.

In the meantime, internet service providers and the "meat market" can also expect the joy of EC market study questionnaires.

Thursday, 25 November 2010

So What Happened To The Van?

We've all heard the story of how 10,000 students were too busy protesting about education fee increases to stop a bunch of photographers taking snaps of someone surfing on an old van the police conveniently abandoned in Whitehall on Wednesday. But where's the van now?

If in its coverage of Wednesday's generally peaceful demonstration the UK's biggest selling newspaper thought the van was so important that it should run the headline "Student mob in cop van rampage" the people should be told what happened to it.

Or is a poor old orphan police van set upon by a few nutters just another victim of lazy, sensationalist journalism?

Wednesday, 24 November 2010

Call for Self-regulation of Limited Network Payment Schemes

The UK Treasury is calling for self-regulation to ring-fence funds relating to stored value in “limited network” programmes, citing examples such as store cards, coffee shop cards, fuel cards, transport cards, membership cards, and meal and other voucher systems. The call is part of the Treasury’s consultation on the second E-money Directive which imposes similar obligations on the operators of 'general purpose' stored value programmes. While limited networks will remain exempt from E-money and payment services regulation, the Treasury will consider “whether further [regulatory] action is warranted” if what it sees as adequate self-regulation does not emerge. Consultation ends on 30 November.

Potential reasons cited by the Treasury for segregating limited network funds from operators' own corporate funds include:
  • Apparent uncertainty as to the scope of the limited network exemption;
  • A large number of consumers/businesses rely on limited network programmes and may suffer if programmes fail;
  • A limited network failure may harm the reputation of other limited network programmes as well as regulated e-money providers; and
  • Limited networks enjoy a cost advantage over regulated general purpose stored value programmes, partly through not needing to ring-fence funds equivalent to the outstanding stored value.
Whether each of these is really a problem is very much debatable. Guidance can clarify what is considered in or out of the regulatory scope, and the existence of 'grey areas' at the perimeter is no argument for definitively expanding the scope by requiring self-regulation. Of course, not all customers or businesses rely on all limited network programmes, or even the programmes of the same type. Similarly, the failure of one programme does not necessarily reflect on them all. That's clear from the collapse of retailers that entirely rely on pre-payment Farepak (Christmas hampers) and WrapIt (wedding gifts) which have provided the genesis for concern in this area generally, though neither was a stored value programme. Finally, why shouldn't there be cost advantages to running a programme whereby value can only be spent within a limited network, rather than one where stored value can be spent anywhere? The latter is always going to be much larger in scale and purpose, and entail far more operational risk.

While the evidence of detriment is less than clear, positive reasons not to introduce requirements to safeguard customer funds in limited network schemes include:
  • The potential for additional requirements to be imposed in the course of the proposed self-regulatory exercise that needlessly increase the cost of operating the network;
  • No one operating a dodgy scheme would sign-up for stringent self-regulation;
  • It may be far more costly and onerous to ring-fence funds in certain types of limited network programmes than others, so some operators may be unfairly discriminated against by not signing-up on legitimate economic grounds; and
  • Increased costs associated with self-regulation may result in fewer limited network payment programmes for customers to choose from and higher retail prices for customers overall.
A proportionate alternative might be to focus on improving the management of operational risk in businesses that rely entirely on pre-payment for specific items, as Farepak and Wrapit did. A nice, long chat with their auditors might also be in order...

Image from

Animal Spirits: My £3 Billion Wedding

Hang on. This might just work. One hell of a Big Splash for the long-awaited wedding of William and Kate. Timed to occur hot on the heels of likely Spanish and Portuguese bail-outs. The more it costs, the better, since we're effectively paying ourselves to celebrate it, and it may also drag in £620 million. That's an impressive number, in terms of direct sales of copy dresses and cheap crockery, yet disappointing... unless the expression of public joy acts as a 'confidence multiplier' for a beleaguered populace.

Perhaps you can tell that I've been reading Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Worth reading. Boosts optimism ;-)

Sunday, 21 November 2010

Of Sunlight, Shadow Banking and Horizontal Intermediation

Huge thanks to Gillian Tett for pointing out in Friday's FT the report on "Shadow Banking" by staff of the Federal Reserve Bank of New York. It even comes with a handy map, which she points out:
" a reminder of how clueless most investors, regulators and rating agencies were before 2007 about finance. After all, during the credit boom, there was plenty of research being conducted into the financial world; but I never saw anything remotely comparable to this road map."
The NY Fed's report defines "traditional banks" as depository institutions that are insulated by public sector insurance from sudden 'runs' on deposits. Whereas "shadow banks" - finance companies, credit hedge funds, broker-dealers and an alphabet soup of intermediaries - operate without any such public sector insurance. I'll come to what shadow banks actually do shortly. But the fundamental problem, as the report makes clear, is that the shadow banking system has indeed gained access to the public purse during the financial crisis, via bail-outs of some of their subsidiaries (bank subsidiaries, in the case of 'financial holding companies' or retail/commercial banking groups; and industrial loan companies and federal savings banks, in the case of diversified broker-dealers or investment banks):
"The liquidity facilities of the... government agencies' guarantee schemes were a direct response to the liquidity and capital shortfalls of shadow banks and, effectively, provided either a backstop to credit intermediation by the shadow banking system or to traditional banks for the exposure to shadow banks."
In other words, public sector guarantees are necessary to stop 'runs' on the shadow banking system in the same way they avoid 'runs' on deposit-taking banks.

In these circumstances, you could be forgiven for thinking it crazy for the shadow banking system to go unregulated. But who are the shadow banks? What do they really do? Does each function really need to be regulated? If so, why? How? This has been the focus of the European regulatory agenda (including a focus on unregulated derivatives) during the past few years, and the harsher elements have met fierce resistance with allegations that the realities, wider implications and scope for unintended consequences are not well understood by legislators and regulators.

So the publication of the detail in NY Fed's report is very much worthwhile.

The NY Fed concludes that 'some' but not all segments of the shadow banking system are of "limited economic value". It says that "equally large segments of it have been driven by gains in specialisation" and would be more aptly described as a "parallel banking system." Nevertheless, the report concludes that "private sector balance sheets will always fail at internalizing systemic risk. The official sector will always have to step in to help."

So how does the shadow banking system work? Well, instead of making loans to hold onto them, like traditional banks, the shadow banking system involves the making of loans for sale through a series of intermediaries - "shadow banks" - each of which specialises in one step in "a vertically integrated, long, intermediation chain":
"These steps essentially amount to the “vertical slicing” of traditional banks’ credit intermediation process and include (1) loan origination, (2) loan warehousing, (3) [Asset-backed Security or ABS] issuance, (4) ABS warehousing, (5) ABS [Collateralised Debt Obligation, or CDO] issuance, (6) ABS “intermediation” and (7) wholesale funding... Typically, the poorer an underlying loan pool’s quality at the beginning of the chain (for example a pool of subprime mortgages originated in California in 2006), the longer the credit intermediation chain that would be required to “polish” the quality of the underlying loans to the standards of money market mutual funds and similar funds."
In reality, these chains could involve many more steps and "CDOs squared", depending on how many times the loans had to be "polished". The various exhibits in the report illustrate the eye-watering complexity very well.

Having studied the various processes, the NY Fed believes that "regulation by function is a more potent style of regulation than regulation by institutional charter." Figuring out which functions contain the root cause of our current financial woes is therefore necessary.

The NY Fed believes the current financial crisis grew out of mispricing of ABS CDOs, (steps 5/6 above), which caused problems up and down the chain:
"...the growth of ABS CDOs not only masked but also created an underlying pricing problem in the primary ABS market (Adelson and Jacob, (2007)). In particular, in the early days of securitization, the junior tranches of home equity deals were purchased by real money investors. However, these investors were pushed aside by the aggressive buying of ABS CDOs, which resided on the trading books of large broker-dealers. The mispricing of the junior ABS tranches permitted issuers to distribute loan pools with increasingly worse underwriting. ABS CDOs suffered from the same underlying problem as the underlying ABS, which required the creation of CDO-squared products."
In essence, poor quality debt was re-packaged again and again in order to remove the risk, but the risk was misunderstood and the resulting instruments were mispriced each time.

Notwithstanding these pricing problems, the NY Fed's regulatory vision is that vertical credit intermediation can reduce the costs of screening and monitoring borrowers in the traditional banking model, and facilitates investor diversification, by transforming credit quality, maturity dates and adding liquidity. And the grading of securities by a "credible rating agency" can reduce information asymmetries between borrowers and savers.

Yet this assertion meets a series of fundamental challenges, not all of which are explicit in the report:
  1. The separation of lender and borrower, and fragmentation of the original loan note makes it harder to adjust loans when borrowers get into trouble (explored in Confessions of a Subprime Lender and evident from the 'fraudclosure' and 'forced repurchase' problems in the US).
  2. The process of transforming 'maturity' (changing the date when loans or debt instruments are due to expire) creates balance sheet risk for the intermediary.
  3. It is unclear whether ratings, accounting and audit functions really do remove information asymmetry between borrowers and lenders. Do we have "credible" ratings agencies, when only three dominate the market and they are paid by the issuers of the securities they grade? Similar problems exist in the accounting and audit markets - hence the calls for reforms in these areas.
  4. There are huge challenges to undertaking adequate due diligence on large volumes of underlying original loans.
  5. Pressure to reduce the amount of capital required to operate this vertical chain of intermediaries results in a game of regulatory, tax, capital and ratings arbitrage that spans the globe and creates endlessly complex corporate structures.
  6. Various factors lead to underestimation of the capital required for the private and implicit public sector guarantees required to support it. This is further complicated by the fact that "...the performance of highly-rated structured securities... in a major liquidity crisis... become highly correlated as all investors and funded institutions are forced to sell high quality assets in order to generate liquidity."
  7. The knowledge that the market can ultimately 'put' problem securities on the taxpayer (whether this is explicit, implicit, direct or indirect) creates a moral hazard that seems to increase in line with the demand for the securities until the system irretrievably melts down.
These fundamental challenges and the length of time it is taking to confront them underscore the need to find alternatives to the vertical model for credit intermediation. The situation is all the more urgent, given that the huge taxpayer bail-outs of the past few years have only reduced the liabilities in the shadow banking system from $20 trillion in March 2008 to about $16 trillion in Q1 2010, when liabilities in the traditional banking system were about £11 trillion.

One alternative is horizontal credit intermediation, which is a feature of the new peer-to-peer funding platforms - like Zopa, Lending Club and Funding Circle - that each borrower's loan amount is provided via many tiny loans from many different lenders at inception.

That approach does deal with the fundamental challenges outlined above, mainly because the margin between lending and borrowing rates are too slim to support more than one intermediary. The one-to-one legal relationship between borrower and lender/loan owner is maintained for the life of the loan via the same loan origination and servicing platform (with a back-up available), allowing for ready enforcement. The intermediary has no balance sheet risk, and has no temptation to engage in regulatory, tax or other arbitrage. Loan maturities do not need to be altered to achieve diversification across different loans, loan terms and borrowers. The basis of the original underwriting decision remains transparent and available as the basis for assessing the performance of the loan against its grade, as well as for pricing the loan on any resale or refinance, making due diligence easy. To the extent that credit risk were to concentrate on certain borrowers or types of borrowers, those risks would remain visible throughout the life of the loan, rather than rendered opaque through fragmentation, re-packaging and re-grading. The scope for moral hazard is contained by the transparency around loan performance.

This also reflects a trend towards the democratisation of markets that impact consumers.

But I would say that, wouldn't I?

Thursday, 18 November 2010

Kick Out the Kick-out Bond

John Kay has seized upon the 'kickout bond' as an excellent example of how our creaking financial regulatory framework works against consumers.

John focused on the product as offered by RBS and distributed by Barclays Wealth, but even the Skipton Building Society is at it.

It is not possible to do the product any justice by summarising it in plain English. By all means study it yourself. But my reaction, like John Kay's, is to wonder why a retail bank or building society would offer an investment product with apparently massive bonuses when they can borrow money - or attract deposits - by offering very modest savings rates? If they've done their homework, this product should be very, very unlikely to cost them any more. In fact, the structure and layers of intermediaries involved should mean additional revenue based on fee and dealing charges and returns below the trigger for any 'bonus' payments. As Mr Kay says:
"Like so many structured products, these bonds are bought only by people who do not really understand what they are doing."
Why the FSA allows a product of this complexity to be offered to unwitting investors, yet refuses to provide guidance for the launch of simple, transparent, low cost funding platforms is utterly beyond me.

Remember: you're on your own - pay less, diversify more and be contrarian.

Avoiding The Irish Haircut

It seems that if you look into any property bubble you'll see the hollow remains of a British bank. Which explains George Osborne's offer of a direct loan from the UK to the Irish government.

It has been made clear by the German government recently that the holders of Irish bonds must take a 'haircut' - a reduction in the value of their bonds - to share the pain in the event that any European money is used to bail out Ireland or its banks.

To the extent that European money involves the European Financial Stability Fund, then the UK would be on the hook for £7bn. Chickenfeed, you say, compared to our own bail-out costs to date, though a sizeable sum in the scheme of recent budget cuts.

But that's not all that's at stake, because the usual suspects filled their boots with about £140bn of Irish assets, according to Channel 4 news tonight, of which RBS and Lloyds share about £80bn. So these positions don't need to take much of a haircut to exceed the UK's £7bn exposure via the ESFS.

Hence George's anxiety to avoid Ireland's trip to the Brussels barber.

What next? British banks were said to be 'tight-lipped' about the exposure to the PIGS. I'd say that's more like "white-knuckled" by now.

Image from Gals Rock.

Friday, 12 November 2010


Has a week gone already?! The distinct lack of posts has been due to my being buried by business-as-usual, plus:
Have a great weekend!

Image from PubSub.

Thursday, 4 November 2010

Strength in Diversity

Following the discussion on the concept of a Social Finance Association, it was interesting to read the guest post on Zopa's blog by Rob Garcia, Senior Director of Product Strategy at Lending Club, attempting to classify types of social finance as 'crowdfunding', 'microfinance' or 'peer-to-peer lending or investing'.

Having had to spend far too long studying the distinctions between US and UK regulation in this area, I must respectfully disagree that 'crowdfunding' necessarily involves 'pooling' or a lack of nexus between 'funder' and 'fundee'. Similarly, any of these models should be capable of operation on either a for-profit or not-for-profit basis, or for any purpose, social or otherwise. The essence should be that each facilitator enables people - rather than the facilitator itself - to determine the allocation of their own funds directly to other people, businesses or projects, whether the businesses or projects are operated for-profit, social purposes or otherwise). In other words, people remain in day-to-day control of the management of their money, not the facilitator.

While precise distinctions between the various different social finance models may be important at one level, and a diverse range of business models is certainly good sign for the strength of the sector, the sector must also be ready to differentiate itself from traditional financial institutions and models - unless it wants to be regulated in the same way.

Social finance models were vital alternatives before the global financial crisis, let alone now and for the foreseeable future while traditional institutions adjust to new capital and regulatory constraints. But the existing regulatory framework makes it painfully slow and expensive to launch social finance platforms. To help foster confident innovation and competition, and enable the new sector to flourish quickly enough to provide much needed funding, financial regulators should clarify what is permissible within or outside the scope of regulation.

Image from the Trade Association Forum.

Wednesday, 3 November 2010

Long Now

The Long Now Foundation "was established in 01996 to creatively foster long-term thinking and responsibility in the framework of the next 10,000 years." It has three main projects - "to construct a timepiece that will operate with minimum human intervention for 10,000 years... to preserve all languages that have a high likelihood of extinction over the period from 2000 to 2100... and to propose and keep track of bets on long-term events and stimulate discussion about the future."

The foundation also conducts "Seminars About Long-term Thinking". In fact, there's a Long Now "Meet-up" in London tonight, and Chris Skinner of the Financial Services Club recently compiled a great collection of blog posts, SIBOS discussions and comments in a document called "Introducing Long Finance".

It's quite liberating to think in terms of a 10,000 year framework, though one could get bogged down in the best way to go about it. I'm not sure it matters whether one thinks about how the world will be in the year 10,000 or 12,010 and what we might do today to ensure there actually is one, or whether you roll forward 10,000 years only to look back at what might then be considered to have been the big problems of today. In any case, it's at least a very different perspective on human existence to the one I was taught.

Of course, we already tend to this sort of analysis when we talk about landing our grandchildren with financial and environmental problems, but that's not very far in the future, and most of our institutions seem pressured for one reason or another to focus on the very short term.

For what they're worth, my own thoughts - partly reflected in earlier posts and partly in response to "Introducing Long Finance" (ILF) - are these:
  1. It is critical to bear in mind that almost all significant events in history are Black Swans - surprise events that have a huge impact and which we rationalise by hindsight. As a result we should maximise our exposure to the upside of such events, and minimise our exposure to the downside (see The Black Swan).
  2. We should focus on the total cost of our activities, rather than merely their immediate market 'price' - i.e. not only the retail price of petrol at the pump or the spread between savings and lending rates, but the cost of subsidies and cross-subsidies paid to each of participants in the supply chain.
  3. It doesn't seem worthwhile to get too caught up in debating the rate at which certain energy sources are 'running out', when it seems likely that it will come as a surprise that they have, in fact, run out or at least become unaffordable (see above). Given the implications of running out of energy on a mass scale, any degree of scarcity is reason enough to create viable, sustainable alternative energy sources now. Otherwise we are exposing ourselves to the massive downside associated with a surprise event. This is the sort of thinking that led the Dutch government to spend €450 million building the Maeslant barrier, for example (page 6, ILF).
  4. Education and health are more critical to our survival - and therefore of greater social importance - than the accumulation of wealth. But we have a tendency to let the accumulation of wealth dominate our activities from time to time. And then we get burned, either by military conflict or economic hardship (read in The Ascent of Money). We should therefore incentivise the pursuit of knowledge and good health above the accumulation of wealth. The process of accumulation of wealth should also be harnessed in favour of education and public health.
  5. Migration will remain a very significant source of conflict, since population imbalances - whether caused by social policies like China's one-child policy or declining population - must result in significant relocation of people, whether peacefully or by conquest.
  6. I agree that "commodities, capabilities, processes and capital" are key drivers of international tension (page 20, "Introducing Long Finance"). But I don't believe the long term issue is one of which nation will be the next global superpower. In fact, the trend may be towards the devolution of national power into regional and local power (see comment on page 26, ILF), Scotland and Wales being examples close to home, and commodities etc are not evenly distributed within most countries. So the economic challenge becomes one of matching regional/local strengths, weaknesses, opportunities and threats in terms of commodities, capabilities, processes and capital (labour included). Hans Rosling's analysis of regional human development, the rise of the "Cheetah Generation" in sub-Saharan Africa and the aid-investment dichotomy illustrated by China's involvement in that region are illustrative of this trend. Issues of fairness, inequality (page 32, ILF) and the total cost of our activities (#2 above) arise to be resolved in this context. The ideas of Bernard Lietaer and the Japanese currency of ‘fureai kippu’, that enables families to exchange time and duties in support of each others' parents and grandparents (pp 37-40, ILF) are also attractive here.
  7. A focus on the eradication of "poverty" (see page 30, ILF) seems a futile as an end in itself. It should be a bi-product of prioritising education and public health over the accumulation of wealth, as well as meeting the challenges arising out of regional/local economics and migration, as discussed above.
  8. Industries naturally concentrate and fragment, while customer dissatisfaction and the competitive activities of players normally considered to be in other markets play a role. This dynamic has played out in the past decade via the Web 2.0 or 'social media' phenomenon in the retail, travel and entertainment industries, for example. I've covered this in the consumer finance context already. And there are signs the markets for audit services and credit risk ratings will be next. So I disagree with Chris's contention that banks have a future as "safe keepers of information", in the way that "Apple’s iTunes, Amazon’s Superstore (it’s no longer books) and Google are all data businesses who use the rich analysis of data as their key resource" (page 46, ILF). I disagree partly because that would buck the social media trend generally, and partly for the very reason that those social media based businesses developed their rich data capability first, and are implicitly more competent in this respect than retail banks (who actually have little such readily accessible data or relevant skills and resources). Instead, the functions associated with retail and commercial 'banking' today are likely to be subsumed and concentrated into other types of businesses more closely aligned with end-to-end retail and commercial processes. Those businesses are in turn likely to fragment to create new types of service provider aligned with the regional/local economic developments, new currency models, shifts in population and so on, discussed above.
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