Looking ahead

Matthew Taylor is another one who thinks that the current crisis represents a political turning point (in terms of political ideas rather than party politics). As I have said before, I remain to be convinced, though I do think the opportunity is there. He's certainly developing some decent arguments in favour, in part drawing on the behavioural stuff that I often bang on about. He'e currently writing a series of posts about 'new progressivism' which are worth following. Here's a chunk from yesterday's post about individualism.

[I]n recent years, as the critique of political and analytical individualism has grown, three important new arguments have been added to the progressive case. First, measures of self defined well-being at the aggregate level contradict the assumption that greater freedom leads to greater personal satisfaction. As Avner Offer shows in ‘The Challenge of Affluence’, and as research by Andrew Oswald and by Andrew Oswald and by Richard Layard has reinforced, greater personal freedom and affluence do not seem to be leading to more enjoyable lives. Also, greater personal freedom seems to be associated, if anything, with a higher incidence of pathologies ranging from obesity to violent crime.

Second, social science (in particular social psychology and behavioural economics) has convincingly demonstrated the systematically non-utility maximising nature of human preferences and actions. For example, human beings are bad at both calculating and acting upon what is – according to their own stated views - in their best long term interests. Quite apart from its impact on individuals this can have problematic social consequences, seen, for example in the inadequate pension savings rate in societies like the US and UK which most emphasising economic freedom.

Third, neuroscience has finally exploded the myth that human behaviour can be fully, or even adequately, seen as being primarily the result of conscious calculation. Most of what we do (arguably, all that we do, but this is a bigger philosophical question) is the result of unconscious responses to external stimuli. The mind does not police the boundary between the individual and the world outside, instead the individual is a nodal point in a web of unconscious stimulus and response. Indeed, from the perspective of neuroscience it is easier to argue there is no such thing as the individual (understood as the conscious, independent decision maker) than there is no such thing as society.

Minsky snippet

My current bedtime reading is Hyman Minsky's Stablizing An Unstable Economy, which I've never read before. It probably would have made more sense to read it last year when everything was starting to kick off. I'm not finding it the easiest of reads either. But there's a lot of good stuff in there. Here's a brief snippet:

Whenever rapid innovations in ways of buying money and in substitutes for bank financing take place, the articulation between Federal Reserve policy actions and the volume of financing available loosens. The greater the number of alternative position-making techniques available for banks and for other financial institutions, the slower the reaction of the supply of finance to monetary policy of the Federal Reserve. The lag between restrictive actions by the Federal Reserve and a supply response by banks and financial markets will take longer when evolution is occuring than when a tight and invariant relation exists. Policymakers' impatience to get results will tend to make for serious excesses and overshoots when relations have been loosened. The likelihood that policy action will result in the economy going to the threshold of a financial crisis increases with the number of markets used for position-making, and with the proportion of bank assets bought through the various markets. Thus, as the financial system evolved over the postwar period, the potential for instability of the economy increased.

The globalisation of xmas

Being a sad sort of person, I thought I'd have a root around in the left over packaging from xmas presents me, Mrs Tom and our future bundle of joy received this year to see where it was made. Here's the stuff I could find -

Wallamoppi game - China
Portable IQ test - China
Mariokart game and wheel - Germany
Jellycat bear - China
Dental set - Taiwan
Beard trimmer - China
Babyliss hairstyler - China
Singing giraffe - China
Condiments set - Italy
Sudokube - China
Babygro - India
A small toy bear - UK!

Obviously some of the things on the list were made for companies that are based in Europe.

When in doubt, blame the regulators, part 2

What is the principal cause of the financial crisis, according to David Cameron?

The greatest failure has been regulatory failure.

This is a silly thing for Cameron to put his name to. Politics aside (temporarily) I think this is fundamentally wrong. Surely the principal responsibility for failures at the banks lies with the boards of the banks themselves, otherwise why are they getting paid so much? If it's actually regulators that have most responsibility for ensuring the survival of the banking sector then surely salaries ought to be adjusted accordingly...

Being more serious, I don't dispute that regulators haven't done the best job, but there is no way that I would place regulatory failure top of the list of the causes of the crisis. This is becoming a popular theme in Right-leaning commentary on the crisis (and of course the self-serving guff coming from some in the City - stand up Nicola Horlick), and I actually think it poses something of an opportunity. To suggest that regulators deserve more blame than bankers comes across as an attempt to rewrite history in order to maintain an existing world view, and I suspect it sounds like a 'political' opinion rather than a gut response. As such it also feels out of touch with the popular mood. We could do worse than reuse Cameron's line repeatedly back against him.

The rest of the article is also worth a skim. The bit where he claims that the Tories got there first in terms of standing up to corporate Britain also raised a smile:

Sceptical of that last claim? Well, try this New Year's quiz. Which party: a) first set out how to ensure that non-doms paid a fair share of tax; b) suggested that in the private equity industry what looks like income should be taxed like income, in response to concerns that multi-millionaires were paying less tax than their cleaners; c) spoke out about a range of irresponsible marketing – from Lolita beds to padded bras for children; and d) called on the Financial Services Authority and other institutions to prosecute financial crime with the same gusto as in the US? The answer in each case is the Conservative Party.

I just want to focus on the claim about private equity. I was blogging about PE week in week out last year, and I think the argument that the Tories were making the running on the tax issue is thoroughly dishonest. Only in March last year George Osborne was kissing the rumps of the PE industry and defending their pay against us loony trade unionists (didn't stop him nicking the phrase he once derided either). He clearly suggested in his speech to the BVCA that the tax structure was safe as long as the industry was more transparent. And looking back over my own posts, it appears that Osborne only floated the idea of a review of PE taxation in middle late June, when Gordo had already told the GMB at the start of June that the Govt would be carrying out a review.

The value of value

Here's a snippet from The (Mis)Behaviour of Markets by Benoit Mandelbrot about the attempt to ascertain value in markets which rang quite true with me:

Value is a touchstone to most people. Financial analysts try to estimate it, as they study a company's books. They calculate a break-up value, a discounted cash-flow value, a market value. Economists try to model it, as they forecast growth. In classical currency models. they input the difference between US and Euro zone inflation rates, growth rates, interest rates and other variables to estimate an ideal 'mean' value which, over time, they believe the exchange rate will revert.

All this implies that value is somehow a single number that is a rational, solveable function of information. Given a certain set of infomation about an asset - a stock, a bond, or a pair of wooden culottes - everybody if equally well-placed toact will deduce it has a certain value; they will all hang the same price tag on it. Prices can fluctuate around that value; and it can be hard to calculate. But value, there is. It is a mean, an average, something certain in a chaos of conflicting information. People like the comfort of such thinking. There is something in the human condition that abhors uncertainty, unevenness, unpredictability. People like an average to hold onto, a target to aim at - even if it is a moving target.

Strange blogfellows

A quick doff of the cap to bloggers who do not dress to the Left...

Firstly, after maintaining radio slience on her blog for a few months Going Private returns with a whopper of a post in defence of the Chicago School that is worth a read. As usual whilst I'm not on the same page, there are a few direct hits in there, especially in respect of the intellectual laziness of many critics of free markets:

If only we hadn’t deregulated so far. Of course, no proponent of these positions seems to have any real grasp of how regulated and artificial mortgage markets were at this point- but that takes some work to uncover through the miasma that is today's political rhetoric on the subject. That, in short, is too much work to try and understand.

Pretty accurate for a lot of us lefties I suspect.

Separately I thought I'd mention that I spent an enjoyable couple of hours in the bar with some Rightie bloggers just before xmas, at the invitation of Nick from Capitalists@Work. Also there were Cityunslicker himself from C@W, Dizzy, Devil's Kitchen, Croydonian and Blue Eyes. I'm sure some of you will be disappointed to hear that they were all normal, and a couple of them are ex-Trots. There seemed to be a bit of a consensus that the Right blogosphere is more libertarian than the Right in the UK as a whole. Not a surprise really I guess, but interesting that they recognise this.

Finally, there's quite an interesting blogging duel between Richard Murphy and Tm Worstall here.

I'll be posting some of my own ill-informed blah shortly.

Hagorama

Last night's Panorama was a bit disappointing. I understand that the Beeb is pleased that it has in Bobby Pesto an intelligent business journalist who actually gets major scoops, but why do they think we want to watch a love-in about how great he is? About ten minutes of last night's programme was wasted, meaning that interview material from key players was cut to accomadate it. It's actually really cringe-inducing to watch too, almost as bad as when the Observer 'interviews' its own staff. Which is a shame as when it got onto the meat of the programme it was worth the wait, if only to be reminded just how close the entire banking system came to collapse. But basically a bit of a squandered opportunity given the standing of the interviews.

PS. Mrs Tom said (with no prompting!) that Alistair Darling came across well.

Gieve on interest rates

Sir John Gieve’s comments to Robert Peston are quite interesting, and tonight’s Panaroma sounds like it will be worth tuning in for. He explains some of the thinking behind the failure to increase interest rates earlier to deflate the housing bubble. He also goes on to talk about the limited value of interest rates as an economic policy tool, and goes on to suggest that alternatives are required:

I think that one of the main lessons from this is that we need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks.
Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand... I think we need to complement interest rates, which are a blunt instrument - you set one interest rate for the whole economy - with something which is more financial-sector specific.

Here’s a response from Nick @ The Capitalists.

The striking thing about Gieve’s comments is how well (comparatively) they have gone down. Although today’s headlines are a bit hysterical, the actual reporting of the interview is far less so. You would have thought that an admission by the BoE’s deputy governor that the Bank hadn’t really grasped the nature of the crisis early on, or that they thought that the housing bubble was separate from the real economy would normally earn them a shoeing. But not today it seems.

Are the business commentators simply too full of xmas cheer to lay into the Bank (again)? Or is it a sign that we can now have a proper debate about economic policy in the meejah, without resorting to ‘exposing’ officials for ‘admitting’ mistakes? Perhaps Gieve’s admission of failure will help us learn the lessons, as Pesto says we need to.

The state's fund manager

There's an interesting piece in the Telegraph today about UK Financial Investments, the company set up by the Treasury to manage its shareholdings in the banks. There's a bi of speculation over the likely non-exec appointments, and it looks like the potential candidates are pretty much traditional City types, plus an HMT representative. They are also planning to flesh out the details of UKFI's role:

UKFI is expected within the next month to publish a framework document that will formally set out its responsibilities. The document will outline the regulatory distance that will need to be maintained between UKFI and Government departments including the Treasury to avoid any potential conflicts of interest.
Alistair Darling, the Chancellor, has pledged that the UKFI will manage the bank stakes on an "arm's-length" basis, although that claim has already invited scepticism from bank executives who have seen the Government turning the screw in an effort to force them to restart lending to homeowners and business customers. The framework document will define exactly what is meant by the "arm's length" description.
UKFI also plans to publish a manifesto aimed at defining its role to taxpayers, as well as details of its contract with the Treasury to outline its formal asset management mandate.

RSA Tomorrow's Investor report

Just a follow-up plug for the RSA’s Tomorrow’s Investor report. I’ve read the report now and it’s got a lot of good stuff in it. The section looking at the nature of ownership is particularly interesting to me, as it touches on a lot of the issues I’ve been banging on about. Here’s a chunk that is fairly close to my view of the world:

However, while shareholders own shares – the equity in the company – it has been argued that the do not in any meaningful sense “own” the company. As the economists John Kay and Aubrey Silberston put it:

No one owns, or could own, BT or Marks & Spencer.Many individuals and groups have rights and obligations around these companies – customers, shareholders, lenders, employees, directors – but none of these claims could plausibly be described as ownership.

Using the legal theorist A.M.Honoré’s classic exposition of the nature of ownership, Kay and Silberston show that shareholders have neither the right of possession nor the right of use, nor several of the other rights we associated with ownership – unless they happen to own every single share.The divorce of ownership and control, they suggest, follows on inevitably from this state of affairs.

And I’m also pretty much in tune with the conclusion – the idea that investing in equities is a form of ownership is inaccurate, but usefully so. Certainly invoking the idea of ownership is a good way to get lefties interested in capital markets!

Ownership may not be the best way to talk about investment in the legal sense, but it can be a useful heuristic – what evolutionary psychologists call an “adaptive fallacy”. In other words, it may be inaccurate, but it is helpfully inaccurate. This is the conclusion of the Tomorrow’s Company report Tomorrow’s Owners:

“Ownership”,while technically inaccurate or only partially accurate, is an excellent word to convey the stewardship dimension because it carries with it layers of meaning accumulated over centuries, relating to rights and responsibilities such as the duty of care.

And yep, there’s behavioural stuff in there too…

Insights from neuro-cake-o-nomics 2

Another snippet from the RSA report:

The behavioural economist David Laibson has conducted two sets of experiments with undergraduates in the United States which show that information can actively hinder decision-making. In the first set, he asked the students to remember a three-digit number, then gave them the choice between a piece of fruit and a big, sticky chocolate bun. Most chose the piece of fruit. In the second set, he gave them the same choice, but this time asked he asked them to remember an eight-digit number – a number right at the limit of our cognitive capacity. The students overwhelmingly chose the chocolate bun. When our brains are stretched, our primal selves override our rational selves. Laibson showed that, when the students chose the piece of fruit, the area of the brain associated with long-term thinking was active. When they chose the sticky bun, it was the hungry, animal side that lit up.

Tomorrow's Investor

The RSA has released its final Tomorrow's Investor report.

TUC trustee seminar on responsible investment

Full details here.

Responsible Investment Trustee Training Day
10am-4pm, Monday 26 January, 2009

Responsible investment has grown hugely in profile and impact, not least with the global success of the United Nations Principles for Responsible Investment (PRI). The need for active ownership and scrutiny of companies has been powerfully underlined by 2008's financial turmoil and the losses sustained by pension funds.

Donald MacDonald, member nominated trustee at BT pension fund and chair of the PRI, has said: 'The increasing support for responsible investment shows that investors have taken a long hard look at the credit crunch, and some of the practices that caused it, and decided they can benefit from more comprehensive analysis of investment risk, one which incorporates environmental, social and corporate governance issues into decision making and ownership practices.'

This pilot trustee training on responsible investment will cover:

? what responsible investing is and is not - eliminating myths

? why responsible investment is integral to meeting fiduciary duty to members

? how to ensure your fund managers focus on members' long-term interests

? linking with trustees of other funds to ensure effective engagement with companies

? practical steps to make progress, including building support for responsible investment on your own trustee board.

This training is for trustees who want to better understand and take forward responsible investing for the benefit of fund members, and are looking for practical support in doing so.

The training is free for members of the TUC's trustee network. It will be delivered by Catherine Howarth (Executive Director of FairPensions and an MNT at The Pensions Trust), Bernie Doeser (a non-exec Director of FairPensions and former Shell Pension Fund trustee), David Pitt-Watson (former Chair of Hermes Equity Ownership Services and author of The New Capitalists) and James Gifford (Executive Director of the United Nations Principles for Responsible Investment).

The training will take place at Congress House, Great Russell Street, London, WC1B 3LS.

Are shareholders stifling bank lending?

There's an interesting piece in today's FT about the pressure that investors are putting on banks to maintain their capital at the same time that the Government is putting pressure on them to loan. Here's the intro:

Politicians and regulators must appeal directly to institutional investors if they are to break the paralysis in the banking sector, the chief executive of Standard Chartered has warned.

Peter Sands, who played a behind-the-scenes role in drawing up the framework for bailing out Britain’s banking industry, said shareholders were encouraging banks to hoard capital at the same time regulators and politicians were trying to restore the flow of credit to the economy.

You can understand the Government's frustration at banks not lending, but are investors being out of order? On the one hand you can see that they don't want to see investee businesses run into difficulties, but on the other are they applying the wrong mindset at the wrong time? Putting pressure on the banks that makes them reluctant to lend will lead to pressure elsewhere in the economy.

Tricky one tho innit?

Madoff wasn't a hedge fund

Further to my post yesterday, and despite my own desire to use the Madoff case to have a pop at hedge funds (!), I think we need to be clear that this isn't primarily a hedge fund issue. I'm nicking the text below, which sets out the facts pretty fairly, from an email I got this morning:

The New York Times, for example, has written "Mr. Madoff was not running an actual hedge fund, but instead managing accounts for investors inside his own securities firm. The difference, though seemingly minor, is crucial. Hedge funds typically hold their portfolios at banks and brokerage firms like JPMorgan Chase and Goldman Sachs. Outside auditors can check with those banks and brokerage firms to make sure the funds exist." For his part, Bernard Madoff had consistently stated that he did not run a hedge fund, and that his primary business was market-making. In a 2001 interview, Madoff compared his firm's role to a privately managed account at a broker/dealer, with the broker/dealer providing investment ideas or strategies, executing the trades, and charging commissions on each trade.... [A]ll incentive fees generated by the trades, all the administration and marketing, and all the investor relations were received or conducted at the third-party feeder fund level - in sharp contrast to the standard hedge fund model.

So 'better' or 'tougher' or whatever else-er regulation of hedge funds is not the obvious problem/answer here. Having said that, those who argue that this has no bearing on hedge funds at all are also wrong in my opinion, because hedge funds themselves did invest in Madoff. There are questions about exactly how they decide what is and isn't a good investment.

The scale of this fraud - if it was it has been reported to be - is mind-bogglingly large. And it is first and foremost a fraud - something that we can't regulate out of existence, even if we can get better at stopping them happening. But the second story here is one of colossal ineptitude on the part of supposedly professional investors. The fact that major investors were taken in is almost as worrying as the fraud itself.

Reading round-up

I don't how I missed this. Unite and Teamsters calling for a corp gov review at National Express.

This piece on Responsible Investor is worth a read. I would say that as it takes a similar line to my own - shareholders weren't acting like owners in the run-up to the crisis.

Dave Osler on Madoff.

Finally, I’ve spotted a couple of books that are worth looking out for next year.

John Kay on the investment world and how to deal with it. He’s also speaking at the RSA.

And George Akerloff and Robert Shiller on “behaviourally informed Keynesianism” (I think I’m going to be a fan...)

Corporate governance doesn't matter

Apparently:

Deutsche Bank has become the latest in a series of brokers to cut back on specialist ESG (environmental, social and governance) services. The bank told clients that it had discontinued corporate governance research and decommissioned its specialist related website earlier this week. Last week, Responsible Investor revealed that JP Morgan had ended dedicated ESG coverage as a result of staffing cuts and would roll it into mainstream equity research. The week before, it was revealed that Citigroup would also be cutting back its in-house SRI research team. A spokeswoman for Deutsche Bank declined to comment on the end of the corporate governance service and would not say whether research staff would be leaving the company as a result. However, sources close to the bank said Deutsche had decided to focus on environmental research rather than corporate governance in order to save resources. The bank has increasingly been tailoring research to climate change issues backing the strategy of its funds subsidiary, Deutsche Asset Management, which has made environmental themes one of its core investment strategies.

Pension funds and equities

I had a conversation last week that was really a sign of the times. A couple of sensible industry people were seriously talking about whether pension funds need to rethink their approach to investing in equities. It's not surprising, I guess, given the events of the past few years. After the post dot-com bubble burst we've seen another surge upwards fizzle out and reverse.


This must be knackering pension funds right now, having only just clawed their way back to better funded position. Most pension funds still put the bulk of their assets in equities, and this is a global downturn, so they can't escape. They must be under a lot of pressure in terms of funding right now. I can only imagine that more nasty benefit reductions are in line for lots of pension scheme members.

People will retort that equities will outperform over the long term, as they ought. But let's be clear that market volatility in the short-term has been a major contributory factor in the death of DB in the UK. Once employers properly experienced the downside investment risk of DB (having enjoyed the contributions holidays and refunds of surplus) they didn't take long to get rid. Whatever arguments we might advance about the long-term liabilities of pension funds, finance directors facing volatile costs aren't going to wait around. In effect in pension funds politics the long term hasn't mattered.

And maybe that is understandable. One of the things this crisis has really brought home to me, as it has featured a second slump in equities within a short period of time, is just how volatile financial markets really are. For all the guff in the City about the ability to forecast trends for sectors or companies the reality is an unknowable future. Taking a punt on equities a lot more risky than those folks trying to talk to you about 'alpha' usually suggest. We may have a much weaker grasp on the true nature of risk in financial markets than we realise, as this bloke argues.

PS. Some people on the Left are looking at this.

Bits and bobs

1. More on Madoff. UKIP blogger Tim Worstall argues that this is not really a hedge fund issue, which is a valid point even if his supporting evidence (a very short post by Brad Delong) isn't up to much. Richard Murphy disagrees.

Meanwhile David Aaronovitch wades in:

By last week I was ready for Madoff. I'd read J.K. Galbraith's reissued 1950s classic The Great Crash 1929 and taken delivery of his point that, in boom times, the rate of embezzlement grows because the promised rewards (Nicola Horlick, please note) don't seem as absurd as they actually are, and the rate of discovery falls off.

There is, as Galbraith noted, a strange period between commission and revelation, when the embezzler is richer yet the victim feels no poorer, so that, in this time, there is “a net increase in psychic wealth”. It's often only when depression knocks and money gets tight that Wile E. Coyote realises that he has run out of road and sees the abyss beneath him.

2. More on public sector pensions. GMB and TUC responses to the CBI call for a review.

3. Foot-in-mouth disease hits Tory blogger.

In defence of public sector pensions

Naomi, the GMB's pensions supremo(!), has produced this rather good list of points of why public sector pensions do not eat babies....

Public Sector Pensions – The Source of All Known Ills

“Oh no they’re not” I hear at least half of you cry as everyone gets ready for panto season. You’d be right of course, but in light of the hideously one-sided press coverage of the issue here are ten facts you won’t have read about in the press:

1. Public sector pensions potentially keep 12million people from reliance on state benefits in retirement.
2. Public sector pension schemes, in particular the funded Local Government Pension Scheme, generate billions of pounds worth of investment in the UK economy.
3. Public sector pension schemes encourage retirement saving among 5.75m public sector workers – 85% of public sector workers are members of a pension scheme (compared with 40% in the private sector).
4. Lack of retirement saving in the private sector will lead to more poverty and significant pressure on state benefits in the future.
5. Greater poverty in retirement resulting from inadequate company pension provision in the private sector will lead to greater pressures on the NHS and local care services.
6. All workers pay for everyone’s retirement income. The price of goods and services includes the cost of private sector pension provision, just like tax levels include the cost of public sector pension provision.
7. State benefits are funded by national insurance and taxation paid by everyone and used more by those with lower incomes e.g. those with inadequate pension savings due to poor private sector provision.
8. Public sector pensions account for about 20% of public sector workers’ remuneration packages.
9. Public sector pension schemes are good quality and rightly so, the country needs private sector schemes to be as good. Lower pensions for all means poverty in old age for all.
10. ‘Apartheid’ was the official policy of racial segregation formerly practiced in the South Africa, involving political, legal, and economic discrimination against non-whites; it is not an appropriate description of occupational pension provision.

When in doubt, blame the regulators

Bramdean Asset Management is the fund manager set up by Nicola Horlick. One of its funds - Bramdean Alternatives - had almost 10% of its assets in Madof Investments, the hedge fund/pyramid scheme which "made off" with lots of its investors' money. In fact, Bramdean has disclosed that Madof Investments accounted for 0.15% of its funds under management.

This is quite clearly a massive and embarrassing foul-up for Bramdean, so it is good that an outfit that has piled its clients' money into a pyramid scheme knows who is to blame:

The allegations made appear to point to a systemic failure of the regulatory and securities markets regime in the U.S. ... This apparent failure raises fundamental questions about the regulatory system under which this has happened and no doubt this will be the subject of intense debate as the facts emerge.

This sort of pin the blame on the regulators approach appears to be becoming increasingly common in the financial world.

I would have thought 'ensuring that a major investment is not a pyramid scheme' would be taken as a given by most clients. Notably they do claim that due dilligence was done, but not by them it appears:

The Madoff business has been subject to due diligence by many of the most experienced professionals in the global markets, including our own advisers RMF Investment Management – Nassau branch, which is part of MAN Group.

So, Bramdean is blaming the regulators for failing to spot the wonkiness of a fund they voluntarily put their clients' money in, plus they suggest that they left due dilliegence up to a third party, despite the fact that this represented 10% of their alternatives portfolio. I know I'm just a simple lefty, ignorant of the ways of the City, but what does Bramdean actually do for its management fee if kicking the tires of a fund that accounts for 10% of one of its portfolios isn't part of it?

Fidelity and Caledonia update

Here's a curious thing. I've checked the Electoral Commission register of political donations regularly over the past few months and nothing has shown up for Fidelity in Q3. Their last registered donation to the Tories was £30K in May. (They've given the Tories just under £500,000 in total since 2004).

Caledonia Investments on the other hand has been spraying the cash around - £58,000 to a range of different local constituency associations since this Feb.

PS. Would it be cheeky of me to point out that one of the fund management houses that the Government now part owns voted in favour of Caledonia Investments funding the Tories this July?

Ownership issues

A few different thoughts about the shareholder as owner idea(l).

1. One interesting theory that has gained a bit of traction over the past few years is that of the 'universal owner', developed by veteran US governance activist Bob Monks. This suggests that investors like pension funds should pay proper attention to externalities, since they effectively own everything. Hence if Company A pollutes and gets away with it this may still hurt the fund because this impacts on Company B, which is also held by the pension fund. It's an elegant way of getting people to think more broadly about the impact of their investment.

It's also got some obvious flaws. Actually even the largest investors do not own everything, even in their own countries. I did some work around M&S this summer and one of the surprising things was that a fair number of investors didn't hold it. Think also about the impact of private equity. Unless you invest with KKR, a UK pension fund won't have any exposure to Boots. Then there's the whole private company sector. And this is before even considering overseas investment. Many funds won't have any exposure to entire countries.

Therefore I think the reality is that as a concept the universal owner idea could only accurately apply to the largest pension funds, like CalPERS, and even then I'm not sure that it holds. I think it's a useful concept for inspiring people to action, but it can't bear much weight in terms developing a better understanding of how things actually fit together.

2. Isn't it a bid odd that the investors that are most committed to the idea of shareholding as a form of ownership tend to be public sector pension funds? Corporate pension funds just don't come close, despite the fact that if the sponsoring employer is a public company it should (in theory) be run in the interests of shareholders/owners. So why don't corporate pension funds seek to act like owners too? Perhaps employer trustees on private sector schemes recognise that they don't want shareholder hassle themselves, so don't seek to inflict it on other companies in which their fund invests. Maybe it's a reflection of the fact that, when you have dispersed shareholdings, the shareholder as owner doesn't really exist outside the pages of text books.

Notably the SRI movement got here first - asking why companies that commit to CSR don't follow through and apply social and enironmental standards to their pension fund's investmets. But actually I think the question of why they don't assert themselves as owners generally is more fundamental. I'm sure many directors do genuinely think they are accountable to shareholders, yet when they have a shareholder role themselves, as pension fund trustees, they don't seek exactly that same accountability from investee companies. By the by we might also ask why public sector funds do seek to make the shareholder/owner idea work. Perhaps they are populated by politicos who are too keen on theory. Or pehaps, like the universal owner idea, the ownership concept is simply a theoretical fig-leaf to enable them to pursue social and environmental issues?

3. Does the wonky nature of the shareholder as owner idea matter? This might seem like a bizzare question to ask in the current climate, when ownership failure seems to have been a contributory factor in the financial crisis. But I do wonder sometimes whether our attempts to make the shareholder/owner thing work are trying to solve a problem that isn't there. I think company directors want to do a good job, and I think many of them would do a good job without complex incentive schemes, or the the constant pressure to deliver quarterly results. Perhaps by trying to crowbar in this shareholder/owner model of the company, often relying on pretty basic rational economic man type assumptions, we've even made the system worse. If Bobby Pesto is right that we are entering a new capitalist era, I would have thought that our ideas about how companies are run, and for whom, need some revision. And this suggests, to me, looking for better way of conceptualising the company-shareholder relationship than 'ownership'.

Massive hedge fund fraud

From the Beeb:

The former chairman of the Nasdaq stock market has been arrested and charged with securities fraud, in what may be one of the biggest fraud cases yet.
Bernard Madoff ran a hedge fund which ran up $50bn (£33.5bn) of fraudulent losses and which he called "one big lie", prosecutors allege.

Wow. Even more interesting is the bit about how he made the thing work -

According to the US Attorney's criminal complaint filed in court, Mr Madoff told at least three employees on Wednesday that the hedge fund business - which served up to 25 clients and had $17.1bn of money under management - was a fraud and had been insolvent for years, losing at least $50bn.
He said he was "finished", that he had "absolutely nothing" and that "it's all just one big lie", and that it was "basically, a giant Ponzi scheme", the complaint said.

For 'Ponzi', read 'pyramid'. That's all this was - a pyramid scheme - yet he had $17bn under management. Wow again.

TPA 'independence' questioned

This is excellent. I think any Labour (or Lib Dem, Green etc) representative who takes part in any debate with the TPA should start by making the group's ideological orientation absolutely clear. They have got away without having their politics exposed for far too long. Anyone who objects to the libertarian Right seeking to act as a voice for taxpayers should get stuck in.

Capital markets campaigning/Band of Bloggers

I had an interesting afternoon/evening yesterday. First up was a seminar organised jointly between the UK Social Investment Forum, Oxfam and Unison focusing on NGOs and capital market campaigning. It was Chatham House rules, which means I can't tell you who said what. But broadly it was split into presentations by two NGO-friendly fund managers, followed by some case studies of NGO campaigns, and an overview of trade union capital stewardship activity from the TUC and Unison.

I thought there was quite a striking difference between the presentations from the union perspective and that of other NGOs. The union approach is more comprehensive, with quite a bit of emphasis on, for example, training up trustees, and strengthening the governance of pension schemes. In contrast the NGOs were almost exclusively interested in one-off campaigns, rather than trying to shape the system. Obviously there is room for both approaches, but you can't help thinking that a bit of cross-fertilisation is in order. It would be nice to see other civil society groups taking up the idea of democratising pension funds for example. But it's also notable that unions lag behind other NGOs in terms of using capital market activism as an extra campaigning tool.

Good seminar all round, and it's encouraging that these groups are talking to each other. I hope the NGOs there who haven't been involved in this type of activity learnt something, and are inspired to undertake similar activity.

After the seminar I headed down to my old workplace, Congress House, to take part in an early evening roundtable about how unions can use blogging more effectively. It was good to put some names to faces, Richard Murphy from Tax Research was there, as was Paul from Never Trust A Hippy, and Mr Gray. Also Nigel from TUC talked about the decision to launch Touchstone, which is developing into a key (and much-needed) Left of centre policy-oriented blog.

There was quite an interesting discussion about the best way to blog. Most of us agreed that the best blogs find their niche and plug away, and that they are less good when they veer into general political commentary. There seemed to be a definite feeling that it could hard for unions to avoid having a dull 'corporate' style blog if they are used to keeping a tight leash on communications. The consensus also seemed to be that general secretary blogs were a bit of a mare. There was also scepticism that blogging could replace journalism (though I don't think anyone had suggested it would).

Anyway, after the seminar we bundled along to the TUC campaigns and comms team's annual xmas bash, where I bumped into some old faces, and John has a picture of us, the creme of Left blogging (!), on his site. I'm on the left, looking a bit sheepish.

Pensions envy

Nigel has another good post about public sector pensions on Touchstone. It seems that, in public at least, the Tories are rowing back from David Cameron's comments on public sector pensions. He said quite clearly he wants them to go DC, and the same drumbeat has been loud and clear from the Tories in the policy world for some time. However it appears that, for now, they don't want to be too explicit about their intentions for fear that it may (rightly) scare off public sector workers from voting Conservative.

The more I think about this, the more I think that whilst it's a superficially attractive campaign issue for the Tories, it also poses quite a few problems for them. And, as I've argued before, it makes sense for the labour movement to starting thinking about the form of their arguments against an attack on pension rights.

First there's the issue of pensions envy (careful how you type that). The argument put forward by Cameron and his Higher Rate TaxpayersAlliance chums is an entirely negative one. It is not at all about what sort of pension scheme would be good/reasonable to provide, it is purely that public sector workers must have worse than they do currently. That leaves the Right open to charges of levelling down and, gasp!, the politics of envy.

It also paints Cameron into a corner of being anti-DB. Whilst those who aren't actually interested in pensions policy (ie the TPA) may not think this is a problem, I think it will alienate part of the small-c conservative pensions industry. A lot of their problem with Labour pensions policy has been that it doesn't give employers enough freedom of movement. But how is a private sector pensions managers going to be able to maintain a DB scheme, or even a hybrid, if the Prime Minister is arguing that DC is best. Where does it leave the likes of the NAPF?

Extending this point a bit further, everyone involved with pensions knows that there are big problems with DC - most notably the risk to individuals - that aren't easily solved. And whilst a lot of the industry thinks that public sector schemes do need some sort of reform, I suspect most would agree that the real problem is the poor provision now in place in the private sector, which some openly argue is a scandal waiting to happen. For Cameron to simply mindlessly promote DC for the public sector as the priority in pensions reform might lead people in pensions to think that he's a bit ...err... lightweight.

Therefore I think there's also a fruitful line of attack to be developed arguing that what Cameron has suggested is pensions vandalism - simply wrecking good provision with no thought to the future. I also wonder whether we might invoke the ghost of Dr Beeching - stick with me! I know there's no link between trains and pensions, but I'm thinking of a way of getting across the idea of short-term policy that knackers things up in the long term in a way that everyone can grasp. Beeching seems to stand in Britain's public consciousness as a warning against short-term cutbacks.

And this is all before the fact that an attack on the public sector schemes would galvanise the unions against it. It could be a protracted industrial battle.

For all these reason, I think this is a much trickier issue than right-wing pressure groups and columnists think it is. That lot have their blood up about public sector pensions, which makes it even harder for Cameron to change tack without looking a bit weak. Probably time to start building the trenches then.

Kuqi coo!

Excuse me a very brief football-related interlude, but I had to laugh about Neil Warnock's comments about former Tractor Boy and footballing blunderbuss Shefki Kuqi:

"He's playing to his strengths and he's doing what he's good at. If he starts thinking he's a footballer, he's a waste of time."

Best description of Kuqi evah.

Pesto: crisis could be more significant than collapse of communism

Blimey. Robert Peston has an opinion piece in The Times, repeated on his Beeb blog, where he indulges in a bit of crystal ball gazing. It's an interesting walk through what has happened, is happening and might happen. And it's got some significant throwaway lines -

Arguably the crisis will turn out to be more significant for us and other developed economies than the collapse of communism.

A New Capitalism is likely to emerge from the rubble, one which may well seem fairer and less alienating than the model of the past 30 years.

But for once, though the article is worth a read, I don't find myself agreeing with the broad conclusions, much as I would like to. For one, the collapse of communism really was the end for particular economic and political model that has not, Nepal excepted, shown any sign of re-emerging as a serious force. In contrast, capitalism is not really under threat, what we are witnessing (as Pesto says) is a rebalancing of the relationships within it. There will be a greater role for the state, there will be less faith in market solutions in some areas, but does anyone seriously (or anyone serious) expect us to tilt the balance back as far as it was during the post-war consensus, for example?

I'm not even convinced that we will necessarily enter an era of kinder, gentler, fairer capitalism, though I hope we will. If we were really going down this route I would expect much more and much deeper analysis of what work is valuable, how we analyse who actually does the important work (ie the relative contributions of management vs grunts), and how we reward people. It's nice to see that a few bankers have decided that they won't take bonuses this year, but does that really indicate anything other than peer pressure, and the desire not be attacked in the street? We will see a year or two of retraint on executive pay, and fund managers may decide they need to vote against management a bit more often. But unless we lock in some changes this will be but a temporary blip, and the trend of increasing inequality will reassert itself.

Whilst this may sound a bit negative, I'm just trying to keep a sense of proportion. I still think the current crisis presents a huge opportunity for change. But just because the crisis is big does not mean that it will kill off the types of ideas that helped to form it.

In it for the long run

I haven't written about the Marathon Club - the grouping of pension funds trying to develop more long-term approaches to investment - for ages, largely because they hadn't seemed to be up to anything. However the other week I bumped into Yusuf Samad, who acts as secretary to the Club, who told me they had a new paper coming out. The paper, Behavioural Aspects Of Investment Management: Lessons From The Credit Crunch, is now on their website.

It's fair to say that the paper pushes a few of my buttons, as it touches both on problems with information (ie investors aren't getting, or seeking to get, the right stuff) and some of the behavioural stuff. Notably they talk about the impact of framing on company reporting, though why stop there, framing surely takes place throughout the investment chain. Maybe it's a sign of my own slightly shifting views, but I'm actually far more interested in what the Club has to say the further it has drifted from SRI. That said, I'm much less convinced that better information or better incentives are going to achieve much change, but then I'm quite cynical about the industry's capacity and desire for change.

Anyway, it's worth a read, here's a few bullets:

• Investment professionals may not be capturing enough of the available information. Investment managers may be too reliant on normal channels of information, e.g. company reporting, EPS, preliminary result announcements, etc. and fail to capture relevant information that may be outside normal channels- “submerged information”. The Marathon Club defines long-term investment as a fundamental, research-oriented approach that assesses all risks to the business.
• Misaligned incentives are widespread throughout the economy and stockmarkets. It may be possible in such cases to create shareholder value through divestiture or restructuring.
• Company reporting may have distortions due to framing. A consistent interpretation of this data that is assumed to underlie market efficiency.
• Quantitative and passive approaches would have little protection if securities are mispriced. Given that securities could be mispriced due to the misaligned incentives, lack of thorough research and distortions in company reporting, passive investors have little protection from loss of capital.

The People's Fund Manager(s)

One of the interesting by-products of the Government's intervention in the UK banking system that hasn't (to my knowledge) had any attention, is the fact that we the taxpayer are now owners of a few management businesses. I'm not on about UK Financial Investments, the vehicle set up by HMT to manage its stakes in the banks, though I think that we ought to think about how we want that to operate too.

Nope, I'm talking about the three asset management businesses that - provided the Lloyds TSB/HBOS merger goes through - we will by extension part own. RBS has its own asset management arm called... err... RBS Asset Management, though to be honest I'd never heard of them before I went to have a look. So presumably that must be quite a small outfit. But the fund management arms of Lloyds TSB (Scottish Widows Investment Partnership (SWIP)) and HBOS (Insight Investment) are both pretty sizeable.

As you've probably gathered from previous posts, I'm not that impressed by the record of institutional shareholders as owners of companies. And I get the impression from his comments at and RSA event a couple of months back that the new City minister Paul Myners doesn't think they've covered themselves in glory either. If that's the case, and if the Government still thinks it's a worthwhile policy objective to try and make the shareholder-as-owner model work, surely this suggests that they ought to take at least a brief look at how all partly-nationalised asset managers are dealing with ownership issues?

For example, does SWIP even disclose its voting record? HMT has been pushing fund managers to do this for two or three years, but I can't seem to find any voting data on SWIP's site. And what if they review the voting and engagement by one of the people's asset managers and discover that it isn't all that? I can't see why the Government should allow its policy objectives in this area to be undermined by any organisation(s) that it part owns. And it would set a very poor example if they don't encourage the fund managers they own to adhere to the best practice the Government has set out.

Right?

UPDATE: it turns out RBS Asset Management is s fund of hedge funds manager. What larks!

Radical policy becomes practical

As I posted previously, I got to see Robert Shiller speak recently, and was pretty impressed with what he had to say. One of his reform ideas was a continous workout mortgage which would enable to reduce payments if they ran into financial trouble. Obviously that sounds familiar because it's one of the features that form part of the Government's agreement with banks about lending. Heather Stewart made the link in today's Observer:

Under the plan, borrowers who are made redundant will be able to reduce the repayments on their mortgages temporarily, echoing a scheme proposed by US economist Robert Shiller for 'adjustable' mortgages that reflect homeowners' personal circumstances.

Shiller's ideas do sound pretty radical when you first read them. But if the Government is willing to try this one out, how about some of the rest of them?

Back from Bournemouth

I've been in Bournemouth for most the past three days, at the annual Local Authority Pension Fund Forum. As usual there was a lot of interesting stuff on the agenda, but the event seemed particularly lively this year no doubt because of the financial crisis. A few highlights -

George Magnus of UBS, who gave the first speech of the conference, was great. Notably, although he said that in the immediate future the economic news was going to be very bleak, he said he was optimistic about the recovery. This was because the politicians and central banks had 'got it' and their collective action was likely to stop the crisis taking an even more nasty turn. He was also broadly pretty positive about the PBR, arguing that although Darling's action plan had a lot of holes, it should work. The most striking thing he had to say, in my opinion, was about the likely longer term impact that the financial crisis would have. He said he expected rocket scientists to go back to making rockets - ie talented graduates are more likely to go into other careers than the City. Engineers will engineer stuff. He also expects therefore more emphasis on productive activity. Coming from a City economist this struck me as pretty big stuff.

From the union side, Jack Dromey gave a good rousing speech and said that Unite was looking into how it might do more work on capital stewardship. Tracey Rembert from the SEIU - who did a lot of great work on the First Group campaign back in 2006 - also spoke, this time about the recent engagement with Exxon. I also met up with a couple of good union reps on local govt funds, and seems that Unison's capacity building is starting to pay off. One of the reps in particular was very up to speed, which is a great sign.

Fund managers got a bit of a kicking. Everyone who spoke on the subject of how well managers address ESG (enviromental, social and governance) issues said that there was a wide variation in practice. In addition most of them don't actually do much beyond voting. Catherine Howarth from Fair Pensions put round and talked about their recent report in fund manager capabilities, and usefully this include some naming of names! This is all encouraging. For too long trustees have assumed that you can just delegate this stuff and managers will do it effectively. This is assumption is fatally flawed and finally it seems that trustees are getting the message. On the negative side, I also picked up on the fact that some institutions are actually letting go of their internal experts on ESG issues because of the need to cut costs. I think we're going to see a bit of a shakeout actually.

That's it for now. I've also got a couple of ideas that came together over the past few dates that I'll transform into posts shortly.

Tory blowback

Good to see I'm not the only one who thinks that the scale of Tory hysteria over Damian Green's arrest might suggest that there is something in this after all. It might be a classic case of getting your retaliation is first, with the aim of prejudicing people's views before they even get to see what the fuss is about. Let's hope the Tories are absolutely rock solid that nothing wrong has occured, or this is going to look like a very cynical operation.

And this is spot on:

Rarely can so many normally reasonable people have lost so many of their marbles. I'm not just referring to the accusations of Stalinism and police state being bandied about. When I read of such grotesque comparisons being made, I genuinely worry for the mental and intellectual balance of those who profess such views. If they know anything about Stalin and police states, it is scandalous and dishonest to make such emotive connections, unless they believe them, which is even worse. If they know nothing, and are just mindlessly repeating mantras they've heard, why are people of such profound ignorance holding political and other posts of influence?

I think it's a general rule in life that accusations of Stalinism (unless directed at genuinely totalitarian regimes) only serve to "out" the user as a complete and utter twassock.

A short break from blogging

I seem to saying this more often, but I'm not going to be posting much this week because of work. Here are a couple of bits that are worth a read:

Will Hutton on Robert Shiller.
Nigel on public sector pensions.

Meanwhile this bit on the Grauniad's markets blog got me thinking. In a sense shouldn't we be worried that the FTSE100 had its best ever week? If you look at what it's been doing lately you see that it's up and down a few % each day. That confirms the idea that market volatility sort of bunches together, for whatever reason. One big uptick on its own really doesn't tell us much more than that we are in a period of intense volatility, surely?

Robert Shiller on tour

I made it along to a Work Foundation seminar this week where Robert Shiller was the guest speaker. I think some of the stuff he has written is really interesting. Irrational Exuberance is an excellent takedown of the efficient markets hypothesis and famously came out at the very peak of the dotcom bubble. But I actually think that The new Financial Order is the most interesting thing he has written as it attempts to put forward some ideas about how to mitigate risk.

At the the seminar his presentation combined both areas of his work. First he had a look at speculative bubbles and the subsequent collapses (1929, 1987 and the 1990s in the stockmarket, and the recent housing bubble) and he made the point very clearly that the current situation can only really be compared in scale to 1929. Shiller's view of bubbles is very definitely that they exist (as I've said before this is disputed by some) and that they are driven by psychological factors. In Irrational Exuberance he says bubbles are naturally occuring Ponzi schems which is a nice way of looking at it. His argument that psychology is key is in contrast to the view that bubbles may arise because of specific policy decisions made by key officials (ie central bank rates). Personally I find his view the most believable interpretation of bubbles, but we can argue about that another day.

In the second bit of the presentation he touched on a few ideas for financial reform, which in essence are really about designing financial services that are a better fit with people's lives. One suggestion he looked at was continuous workout mortgages that allow you to pay less if you run into financial difficulties. He also briefly mentioned his ideas about macro markets.

My general impression was that people were in tune with his critique of speculative bubbles, but less onboard with his ideas for new financial products. And I suppose in a way the section half didn't necessarily flow from the first. That said, it sounds like Shiller is doing the rounds in the policy world and has put his ideas in at a high level. Personally I think there's a lot of good ideas in what Shiller says, though I recognise other TU people aren't quite so impressed (Colin!). One question/point made by one of the policy people there was whether, if the market for the types of products Shiller advocates don't naturally arise, the Government could mandate some of them. I reckon that is a line of thought worth exploring.

J K Galbraith on post-bubble reflection

A snippet from A Short History of Financial Euphoria:

"There will... be scrutiny of the previously much-praised financial instruments and practices - paper money; implausible securities issues; insider trading; market rigging; more recently, program and indez trading - that have facilitated and financed the speculation. There will be talk of regulation and reform. What will not be discussed is the speculation itself or the aberrant optimism that lay behind it. Nothing is more remarkable than this: in the aftermath of speculation, the reality will be all but ignored.

There are two reasons for this. In the first place, many people and institutions have been involved, and whereas it is acceptable to attribute error, gullibility, and excess to a single individual or even to a particular corporation, it is not deemed fitting to attribute them to a whole community, and certainly not to the whole financial community. Wisespread naivete, even stupidity, is manifest; mention of this, however, runs drastically counter to the... presumption that intelligence is intimately associated with money. The financial community must be assumed to be intellecually above such extravagance of error.

The second reason that the speculative mood and mania are exempted from blame is theologiocal. In accepted free-enterprise attitudes and doctrine, the market is a neutral and accurate reflection of external influences; it is not supposed to be subject to an inherent and internal dynamic of error. This is the classical faith, So there os a need to find some cause for the crash, however far-fetched, that is externaal to the market itself. Or some abuse of the market that has inhibited its normal performance."

Measured, reasonable comment from a City boy

From the Beeb's City Diaries section, here's 'Stephen' on the PBR:

During the chancellor's pre-Budget report and the opposition's response, there were alternate gasps of disbelief and jeers of contempt across our trading floor. It's utterly bewildering how our political system has managed to put such innumerates, however well-meaning, in charge of our economy.

I, like many of my City brethren, am a politician's nightmare. I'm a free-thinking, floating voter so I won't cast one party in good light and another in bad. They all have their failings, although the real issue is bigger than any one party. Nothing that was said will really make any difference, because the underlying problems remain and this is why so many City folk view politicians as an amusing but mostly irrelevant side-show. Some colleagues were pounding their desks in despair.

Looking into Libor

A quick plug for a really interesting post on the TUC blog Touchstone, which looks at how Libor gets set. As Adam suggests, most people probably assume that Libor - the rate at which banks lend to each other - is some free-floating measure over which no-one has any control. Not so. This is an area that definitely deserves a bit more scrutiny, so go and have a read.

Heffer's Law holds

From today's Telegraph:

So it should be clear what the Tories have to promise to do should they win the next election... They especially have to promise to scrap the spiteful and iniquitous 45 per cent tax band for those earning more than £150,000 a year, and which will raise a derisorily small amount of revenue.

And from todays YouGov poll commissioned by the... err... Telegraph:

The poll found that 60% of the public supported Chancellor Alistair Darling's announcement of a temporary cut in VAT and 72% welcomed his new higher-rate tax band for the wealthy.

Squeaky bum time

Tory lead cut in post-PBR poll
6 hours ago

Labour has narrowed the Conservative lead to just four points in the first opinion poll taken since Monday's Pre-Budget Report.

The YouGov survey for the Daily Telegraph puts the Tories on 40% (down two points on a similar poll last month), Labour on 36% (up three) and Liberal Democrats on 14% (down one).

Because of Labour's inbuilt electoral advantage, the findings could deliver Gordon Brown victory in a hung Parliament if repeated in a General Election.

The poll found that 60% of the public supported Chancellor Alistair Darling's announcement of a temporary cut in VAT and 72% welcomed his new higher-rate tax band for the wealthy.

But just 28% thought the PBR decisions would benefit them personally and only 27% said that they would lessen the impact of the economic crisis.

The poll - conducted following the PBR on Monday evening and Tuesday - is the latest in a string of surveys to show Labour catching up on the Tories after a summer which saw Mr Brown's party trailing by more than 20 points.

YouGov questioned 1,556 adults across Britain online on November 24 and 25.

Keynes quote of the day

"Of all the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of the investment institutions to concentrate their resources upon the holding of "liquid" securities."

Capital market dysfunction

Just a quick plug. There's another bit from a recent weekend FT worth a look here. It includes a look at some of the critiques of efficient markets, including that of Paul Woolley:

Paul Woolley, a former academic, policymaker, International Monetary Fund economist and asset manager, argues that efficient market theory falls down because of the "asymmetric information" problem. This, simply put, is the difference in the quality of information enjoyed by agents - the banks, fund managers, brokers and so forth - and the principals, or end investors. The agents know more than the principals and exploit this to maximise their own wealth. While this worry isn't new, critics have in the past focused on banking and corporate finance and on abuses such as insider trading. Woolley, however, applies it to investment management, arguing that asymmetric information, especially in this area, has far graver consequences for the functioning of finance.

This "agency" problem leads to two bleak conclusions. First, that capital markets do not necessarily price assets efficiently and capital can be misallocated. When the misallocation grows big enough, as it has now, it can lead to substantial macro-economic dislocation. Second, it allows banks and financial intermediaries to capture too big a share of the economic gains from capital investment, and thus from growth itself. And this share - the "croupier's take" in the celebrated phrase of Warren Buffett's partner, Charlie Munger - has been going up as financiers have become ever more cunning. Woolley argues that big and unstable capital markets make it likely that we will suffer more and potentially bigger upsets in future.

Woolley's analysis differs from that of Soros or the behaviouralists in that it does not require one to depart from mainstream economics. In his vision, the participants in financial markets are all acting optimally and rationally in their own self-interest, while generating outcomes that are less than optimal in terms of growth and welfare. Modern financial markets thus tend, Woolley believes, towards dysfunction. This flies in the face of the inherited wisdom that has prevailed since Adam Smith, and his belief in the power of the "invisible hand".

Behavioural bonuses

Today via someone else (sorry I don't remember who) I came across a recent piece by behavioural economist Dan Ariely in the New York Times on whether bonuses work or not. Now this is based on some experiments, rather than real-life examples, but worth a look:

[U]ndergraduate students were offered the chance to earn a high bonus ($600) or a lower one ($60) by performing one task that called for some cognitive skill (adding numbers) and another one that required only a mechanical skill (tapping a key as fast as possible). We found that as long as the task involved only mechanical skill, bonuses worked as would be expected: the higher the pay, the better the performance. But when we included a task that required even rudimentary cognitive skill, the outcome was the same as in the India study: the offer of a higher bonus led to poorer performance.

Funnily enough I seem to remember something similar in Tim Harford's most recent book - incentive pay only really works very effectively when there is a relatively straightfoward and standardised task and where performance in the task can be accurately measured. So that rules out a lot of activity where people earn really big bonuses.

But arguably the more interesting bit in the Dan Ariely article is the effect of public scrutiny:

We asked 39 participants to solve anagram puzzles, sometimes privately in a cubicle and sometimes in front of the others. We reasoned that their motivation to do well would be higher in public, and we wanted to see if this would affect their performance. But we found that while the subjects wanted to perform better when they worked in front of others, in fact they did worse.
So it turns out that social pressure has the same effect that money has. It motivates people, especially when the tasks at hand require only effort and no skill. But it can provide stress, too, and at some point that stress overwhelms the motivating influence.

So two factors that might ordinarily be assumed to encourage better performance may actually have the opposite impact. This seems to be something worth exploring, to put it mildly.

The 45% rate TaxPayers Alliance

No surprise to see the Right TaxPayers Alliance (as opposed to the far more sensible Other TaxPayers Alliance) straight into bat on behalf of those earning £150K or more. I've just seen some TPA dude argue on More 4 News that a 45% top rate will send a dangerous smell overseas or something. It's not surprising that the Right TPA take this line, as many of their business supporters will be caught by it. There's got to be payback for those donations you know!

Another bank needs public money

Citibank this time. As Pesto says:

This proudest of US banks has been humbled: the rescue is about as close to nationalisation as it's possible to get without the state taking 100% ownership.

Taxing the rich...

I've just about picked my jaw up off the floor after watching the news. The Beeb's Nick Robinson has revealed that the Government is suggesting a new top rate of tax of 45% on incomes over £150,000, to kick in after the next election. Just when you thought the news had started getting back to normal too. A few initial thoughts...

1. It surely won't raise that much money. There just aren't that many people earning £150k and up. As such it will run the risk of coming across as a bit of a populist stunt.

2. It's probably going to be portrayed as the death of New Labour and/or the revival of Old Labour.

3. Precisely because it's on such high incomes it's going to be hard to paint it as a tax on aspiration, as the Tories would no doubt like to. Not great for them to say that they will reverse it if they get in either.

4. It's going to hit many of the people that the punters blame for the financial crisis.

5. It's going to hugely popular on the Left, and amongst disenchanted ex-Labour voters. It's difficult to argue that there's no difference between the parties now.

6. I can't believe Brown would allow this if he didn't expect something similar to happen in other countries.

7. It still might not make any difference to our polling. Just being realistic, like.

WOW!

The difficulty in taking away the punch bowl when the party starts getting interesting

Googling around I stumbled across this piece by Robert Shiller in the New York Times recently. It's really about the problem of group-think in organisations like the Fed, but I was struck by the comments he makes about his own desire not to be seen as too much of a nutter when speaking out about the bubbles in first the stockmarket, and later the housing market.

"From my own experience on expert panels, I know firsthand the pressures that people — might I say mavericks? — may feel when questioning the group consensus."

"I was connected with the Federal Reserve System as a member the economic advisory panel of the Federal Reserve Bank of New York from 1990 until 2004, when the New York bank’s new president, Timothy F. Geithner, arrived. That panel advises the president of the New York bank, who, in turn, is vice chairman of the Federal Open Market Committee, which sets interest rates. In my position on the panel, I felt the need to use restraint. While I warned about the bubbles I believed were developing in the stock and housing markets, I did so very gently, and felt vulnerable expressing such quirky views. Deviating too far from consensus leaves one feeling potentially ostracized from the group, with the risk that one may be terminated."

As I've said quite a few times before, I like the fact that Shiller pays a lot of attention to the psychological factors associated with markets. By that I don't just mean the psychology behind market transactions, but also (as above) the psychology of financial policy, and the psychological effects of economic events. His stuff is well worth reading.

DB stifles PE

This piece in the FT is quite interesting (you need to scroll down a bit for it). The re-emergence of pension scheme deficits is likely to further increase their role as poison pills.

Pension liabilities are large hurdle

More than four out of five private equity groups view the need to reach agreement with the trustees of a pension fund as a significant hurdle to acquiring a company with a defined benefit pension scheme, according to research.

With the government preparing to beef up the powers of the Pensions Regulator and many pension funds facing growing deficits, several private equity groups view pension liabilities as one of the biggest hurdles to completing deals next year.

The biggest worry for more than half the 16 private equity groups that responded to the survey by Punter Southall, the pensions adviser, was the risk that new life-expectancy predictions may inflate the pension-fund liabilities at companies they own.

Richard Jones, principal at Punter Southall, said: "If there is a pension scheme in a company then it is the first thing that private equity [firms] seek external advice on.

"Several clients we used to work with now say they will not touch another company with a defined benefit pension scheme," he added.

The survey found that most private equity groups were sanguine about the regulator's powers. Most found it less worrisome than the potential actions of trustees after an acquisition is completed, or the risk of future legislative burdens.

The Origin of Financial Crises

Just a bit of recommended 'crisis' reading. This is one of the better things I have read about the financial crisis. It's a nicely-written and clearly argued case against the efficient markets hypothesis (EMH) and the argument that left to their own financial markets will tend towards equilibrium. In fact a large part of the author's motivation for writing the book seems to be to drive a stake through the heart of the efficient markets hypothesis, which he sees as fundamentally wrong (no argument here!).

As such the book is broadly pro-Keynes, and very pro-Minsky. It takes as a given Minsky's view that markets are inherently unstable and will inevitably swing between ..er.. boom and bust, and that the busts can be very bad indeed if no action is taken. The suggestion is that Minksy's financial instability hypothesis should replace the EMH has our bedrock understanding of how financial markets work.

Notably this leads him query what central banks are trying to do. He is particularly scathing of Fed, which he suggests tries to combine a belief in the EMH with intervention, when logically they should preclude each other. He argues central banks should refocus their attention on credit expansion and asset price bubbles, rather than consumer price inflation. Notably he therefore believes that bubbles both exist (this might seem obvious, but it's actually an important point) and that central banks can do something about them, though in practice it's credit creation that he thinks should be monitored.

That's the headline argument, but there are lots of nicely structured points building up to it along the way. There's a great section on why even 'fundamental' company analysis on its own can fail to spot the distorting effects of bubbles.

Anyway, definely worth a read, and given that it's both very clearly-written and one of these double-spaced books you can get through it in no time.

The Real Taxpayers' Alliance

Hehe, this is good.

Via Adam.

The human cost of the credit crunch

The Beeb website has some interesting personal stories on it from the frontline of the credit. Daniel (not his real name) who works for an investment bank explains just how painful it is out there –

“As I approached my desk I did not even say the usual "Good Morning" or "How was your weekend?"… People are buying lunch for £5 in the cafeteria rather then spending £20 on some Sushi or Dim Sum outside. People now have breakfast at home or even bring a packed lunch. The days of the one hour lunch are well and truly over.”

Packed lunches instead of sushi? And they say people had it hard in the 1930s.

Bank stuff

There's a stack of stuff to look at today. First up, Unite has put out some stats put together by LRD on remuneration at the banks -

Unite has a detailed dossier exposing the pay of senior executives in the financial services taken from annual reports, between 2003 and 2007. The dossier shows that the basic pay and cash bonuses (excluding share based payments) of just 5 CEOs at HBOS, Lloyds TSB, RBS, Barclays and HSBC totalled over £52 million.

A few executive directors (named in the annual reports) of RBS, LTSB and HBOS, 3 banks which the government will take a £37bn stake in, have earned a combined £122 million in pay and bonuses including over £64 million in cash bonuses alone.

Excluding share based payments, between 2003 and 2007, CEOs Fred Godwin (RBS) made £15.5 million, Andy Hornby made £6.9 million and Eric Daniels made £10,2 million.

The total remuneration (excluding share based payments) for a handful of executives included in the annual reports of the major British finance companies and the majority of UK subsidiaries of overseas parents totals an astonishing £729.3 million.

Unite members are also protesting outside the Lloyds TSB EGM which seeks approval for both the HBOS takeover and the HMT capital injection.

Secondly, the TUC is one of a number of organisations giving evidence today to the Treasury select committee on remuneration at the banks, so it might be worth keeping an eye on that one.

Robert Peston has another punchy piece on his blog about the Barclays deal, this time looking at the large fees being paid to Barclays Middle Eastern investors (over 4% of the total value of the deal). As he says the fees look even more ridiculous in light of the fact that existing investors have snapped up their slice of the RCIs (the bond-like debt bit of the deal)immediately.

Arguably... Barclays has needlessly given away £300m. And don't think this is about losses suffered by funny, remote people in the City with no connection to you. It represents an erosion of wealth for millions of us saving for a pension, since most of our pension funds and life companies have an interest in Barclays. You should be concerned.

Finally Jeff Randall gives the Barclays deal the thumbs up. For him it is clearly an ideological position -

If Varley could rewind the video, he would not start from here. That said, I applaud his determination to steer clear of Government intervention. At 12pc, the Treasury's money would ostensibly be less expensive than cash from desert kingdoms, but it would come with the burden of political strings, the real price of which is always far greater than what's written in the contract.

Notably he makes the point earlier in the piece that small HBOS shareholders are kicking off about the Lloyds TSB merger (which, as the Govt supports it and will have a stake, he doesn't like). True, but I bet you they aren't kicking off half as much as small Barclays shareholders are, judging from my experience this week.

Pluggity plug plug

For Charlie's blog, Excuse Me Whilst I Step Outside, which you can find here.

Game on

I've been so caught up in work stuff I completely failed to spot today's Ipsos Mori poll - Tories on 40%, Labour on 37%. Wonder if Dave knows what he's doing with today's decision to put a bit of clear blue water between the parties? A bit of renewed Tory infighting seems likely given the dramatic fall in the poll lead.

ABI tightens the screw

Wow, I'm a bit surprised by this (from Citywire):

Changes to Barclays' cash raising plans win few supporters

By Deborah Hyde | 14:30:21 | 18 November 2008

Institutional investors have expressed ‘grave concerns’ about Barclays’ capital raising measures, with the new measures taken by the bank appearing to have done little to appease those who oppose the deal.

Despite the bank’s decision to allow institutions to participate in some of its capital raising measures and for its directors to forgo their bonuses, both analysts and shareholders remain unconvinced of the merit of the deal, with one analyst describing Barclays’ latest measures as a ‘small olive branch’.

The ABI, which represents leading opponents Legal & General and Aviva as well as other insurance groups, has slapped a ‘red top’ on the bank.

The group said that the red top, a designation which the organisation rarely dishes out, does not constitute advice to vote against the proposals, but highlights the presence of an issue of grave concern.

It said it had made the decision because the changes announced today did not address all of its concerns.

'These changes cannot offset the concern of shareholders at the serious breach of the pre-emption principle, especially on an issue with a large discount,' said Peter Montagnon, the ABI’s director of investment affairs

The ABI met with Barclay’s management last week to discuss their opposition to the plans to raise £7 billion fin the Middle East.

Barclays folds... a bit

So, Barclays and its Middle Eastern investors have agreed to grant a couple of concessions to investors, one quite valuable, the other pretty meaningless. The former is this bit -

Barclays has also held discussions in recent days with Qatar Holding LLC and entities representing the beneficial interests of HH Sheikh Mansour Bin Zayed Al Nahyan (“the Investors”) who agreed on 31st October 2008 to invest substantial funds into Barclays. The Investors wish institutional investors to be able to participate further in the capital raising. The Board of Barclays today announces that the Investors have each offered to make available up to £250m of Reserve Capital Instruments for clawback by existing Barclays institutional investors at par. By consequence £500m of Reserve Capital Instruments (excluding Warrants) will today be made available to Barclays institutional investors by way of a bookbuild placing.

The RCIs are one of the tasty bits of the deal, as they pay out a generous coupon. Originally existing investors weren't being offered any of this, now they are going to get access to about a sixth of the total. It's a significant move in favour of institutional investors, though small shareholders won't get a look in (though this might not be practical/possible anyway). But there's no movement on the warrants- effectively an option to by Barclays shares in future.

Part 2 of the concessions are as follows -

In recognition of the extraordinary circumstances of the Capital Raising, the Board of Barclays also announces that:

*all members of the Board will exceptionally offer themselves for re-election at the Barclays Annual General Meeting to be held in April 2009; and
*no annual bonuses will be paid to executive directors of Barclays PLC for 2008, following the offer by the executive directors to waive any annual bonus for 2008.

This doesn't add up to much and surely ought to be standard operating procedure for the banks now. On the bonuses Barclays is simply following the now well-established trend that acknowledges that in the current crisis giving your top team rewards for good performance might look a bit wrong, though presumably it will be a bit painful for Bob Diamond.

And does putting all directors up for election at the AGM (and this isn't - yet - even a commitment to annual re-election) really mean much? Perhaps we really are in a new world where institutional investors will pull the trigger if they think directors aren't up to the job. Judged on previous evidence I think we ought to be a bit sceptical. How many directors actually get voted off boards? (admittedly some get knifed before it gets anywhere near a vote). If shareholder don't use the vote effectively, what sort of concession is it?

Unfortunately this kind of 'back me or sack me' initiative plays out in the corporate world rather differently to the political world. Business journalism plays a part here since it tends to play up the idea of superhero chief execs. Business leaders can garner the kind of fawning coverage politicians can only dream of if the organisation which they lead does well, and this attitude seems to seep into many people's views of companies. Therefore when execs pull the equivalent of a John Major resignation it is perhaps not surprising that many investors blink first. If we are ever to get to a position where shareholders really do act like owners this is exactly the sort of issue over which investors ought to call the company's bluff. Here's hoping...

Interesting snippets

On Capital Matters there are a few details about some individual votes that took place during the election that affect investment of assets.

There's another left-leaning website about the current crisis here.

Snowflake has a look at Osborne's comments on Sterling here.

AVPS recasts Charlie Brooker's zombie series Dead Set as the class struggle. (I must put up a zombie post of my own soon).

And Prem Sikka on the Barclays deal.

Barclays again

A bit more news from The Grauniad:

Pressure is mounting on John Varley, Barclays chief executive, and his boardroom colleagues amid growing shareholder opposition to the bank's £7bn fundraising plan.

Pirc, the body that advises pension funds and other major investors, is today urging shareholders to oppose the controversial capital raising at next week's extraordinary shareholder meeting. It wants shareholders to send directors a "clear unequivocal message" that the new investors from the Middle East are not a good solution to the need to raise funds.

The deal is already facing criticism from RREV, which also advises pension funds, and corporate governance advisory group RiskMetrics Group. The Barclays chairman, Marcus Agius, tried to convince major City investors of the merits of the fundraising at a meeting at the Association of British Insurers, which also has concerns about the fundraising, last week.

I still think they will get through the vote ok though.

Bits & bobs

Simon Caulkin has another interesting-ish bit The Observer today about self-interest. He argues that building economic models and rewards in organisatons on the assumption of rational self-interest is both flawed and counter-productive:

"Self-interest contains within it the seeds of its own destruction. It drives for reward, but once rewards reach a certain size it can no longer function as a discipline. When rewards were less high, self-interest was tempered by the need to nurture the reputation a career depended on. With salaries at current stratospheric levels, however, self-interest provides no such restraint, since careers are redundant."

"Anyone who has done one big deal - or worked in the City for more than a few years - never need work again. Far from being a restraining influence, in these circumstances self-interest promotes a short-term focus on transactions that in turn amplifies its second baleful impact: increasing distrust. As anyone not blinded by fundamentalist zeal must see, the obverse of the coin of self-interest is lack of trust - and both are self-reinforcing. The swelling of self-interest is in direct proportion to the draining away of trust, the cumulative results of which are now visible all around us."

Sort of. I think the idea of rational self-interest is certainly flawed, in part because a lot of evidence shows we aren't very rational, and in part because, as I argued t'other day, I think acting in you 'self-interest' covers much more ground than just money or other material rewards. He's got a point about the career-defining deal I'm sure, which does raise the old questions about the structure of remuneration. This sort of stuff does suggest that if we want to really focus on getting the most out of the people in charge of large organisations then we ought to be looking to psychology as much as economics. But I can't see much sign of any desire to do so amongst investors. If the current situation does prove to be a bit of turning point (and I still think it will be) the this ought to be fertile territory to advance some new ideas.

Elsewhere it's interesting to see Osborne continuing to take flak from both us and his own side. His comments on Sterling don't see particularly earth-shattering to me, but at the moment it doesn't really matter. He is clearly seen as wobbling and various parties are more than willing to give him a push. At present it looks like he will survive but, as argued previously, that isn't a bad thing either as I reckon he's already got himself a negative image in the average punter's imagination. Not too much of a stretch to imagine an election poster of him in either Bullingdon Club gear or plus-fours and shotgun ensemble next to some unhelpful factoid or other.

Barclays is my other hobby horse at the moment. A quick read through the headlines today suggests that they aren't out of the woods yet by any means, as some of their large shareholders aren't taking the patently worse deal lying down. The problem is that if Barcalys pulls out they still have to pay £300m in fees to the Middle Eastern investors they have struck the deal with. Given that the deal itself is worth abut £7bn that's quite a high fee too. I still think it will go through, but more fireworks this week no doubt, and more damage to the board's reputation.

Finally, I'm nearly finished The (Mis)Behaviour of Markets by Benoit Mandelbrot (yes, he of the Mandelbrot Set) during which my interest level has reflected market moves - trending upwards for a bit before reversing. But there's some great stuff at the end where he has a pop at the idea of trying to estimate 'real' value in financial markets. I'll post up a chunk shortly.