Mr Tyrie’s 'radical idea’ is not radical enough

There’s been so much in the news that a UK-based economist could be forgiven for fretting over what to write about this weekend.

Inflation rose by 2.7pc in May, we learnt last Tuesday, up from 2.4pc the month before. Then there were the recommendations from the G8 summit in Fermanagh, Northern Ireland.

inhope: The QE time-bomb is ticking. When it goes off the financial markets will panic about the level of debt. Interest rates will gradually return to trend levels and then overshoot. Government borrowing has to fall. The economy cannot grow enough to cover the black hole left by the credit crunch. Inflation is going to tick up. The Euro zone is going to suffer further bank failures.  Yes, we'll see the Cypriot bail-in imposed elsewhere. This is all going to happen at once.

wantonone: What no free lunch, no perpetual motion, no such thing as an easy ride? Inhope that is heresy. When the markets panic where will the money go? Please tell me so I can buy some now, pretty please.

drjonathanwilson: Good comment, Liam. But I would have chosen a different but related subject to be top of the list as it concerns the immediate rather than the mid to longer term. I refer here to the EU banking crisis and the bail-out discussions that constitute a clear and present danger to the UK's financial system and the independence of the BoE. If the Euro area banking systems fails what are the consequences for the British financial system? The risks materialize in different ways between banks in countries within EMU and those outside of EMU but with cross holdings with EMU banks. For example intra-EMU cross holdings result in real advantages for those countries that owe more than they are owed if EMU should break up or that country should decide to leave EMU. This occurs because the spending would have been in Euros but the debt would in all probability be repaid in the devalued local currency irrespective if contractual guarantees (effective default). The EMU based creditor carries the net loss. However if the creditor bank is not EMU based, for example a British bank, then the devaluation risk is off-set by differences in the exchange rate between the new local currency and GBP. Take for example the near net 400 billion euros owed by British banks to Spanish banks. If Spain were to exit the Euro and reintroduce the Spanish Peseta the British banks would repay in devalued Peseta and depending contractual terms, British banks could gain in terms of the amount of GBP required to settle the debt. Having set the general overview of risk we can now consider who will "gain" the most by exiting EMU, defaulting and repaying loans in a devalued local currency (ignoring any clauses relating to some fixed USD equivalent in the case of an exit)?  By looking a the *net* amounts owed intra-EMU, we find the country that has most to gain from exit is Italy with about net 200 billion owing to other EMU area banks. An Italian exit would hurt which EMU area country the most? That would be France with a net 300 billion owed by Italy to France. It is therefore reasonable to conclude that an Italian exit from EMU results in a French exit from EMU and with it comes the devaluation of the approximate 250 billion owed to British banks. This is fortunately off-set by an equivalent amount owed to French banks by British banks which could be repaid in appreciated sterling against a devalued French Franc. So which country in the EMU area would France drag down with it? That would be Germany where France would gain on exit on the net 80 billion Euros owed to Germany. But France cannot exit because of the  300 billion Euros owed it by Italy. We now see why Italy has an EU technocrat for a Prime Minster. Germany is thus surprisinngly not the most exposed country with regards to intra-EMU bank debt at about 140 billion euros. The Germans have other large net EMU liabilities, of course, via the ECB, loan guarantees and Target2 exposure. Thus we see that Italy has most to gain in an exit and France has most to lose. Which brings us back to the question of why is Britain involved in EU bank bailout discussions when British exposure to contagion from the EMU area is relatively limited due to either being a major net debtor to the EMU area banks (especially Spain) or has limited net exposure. France is horribly exposed to default by Italy - so why should the BoE lose its independence to an EU that is tottering on the edge of disaster? That Liam, is the clear and present danger to the UK's financial system and one Mr. Osborne should explain. Vote UKIP for open water between the British financial system and that of most of continental Europe. Jonathan

pumpernickel: Jonathan wrote: "… the spending would have been in Euros but the debt would in all probability be repaid in the devalued local currency irrespective of contractual guarantees (effective default). The EMU based creditor carries the net loss." No matter the debt is repaid in the devalued local currency. At the time of repayment of each tranche the then prevailing currency rate with the €uro will be applied, so the debt will still be repaid in Euro terms.

ryck: In the Argentinian case there were two currencies and the government declared that debt be paid off in the old [worthless by inflation] currency so as not to burden the new one. Neat, for Argentina. Didn't work so well for the creditors 

ryck: However if the creditor bank is not EMU based, for example a British bank, then the devaluation risk is off-set by differences in the exchange rate between the new local currency and GBP. Take for example the near net 400 billion euros owed by British banks to Spanish banks. If Spain were to exit the Euro and reintroduce the Spanish Peseta the British banks would repay in devalued Peseta and depending contractual terms, British banks could gain in terms of the amount of GBP required to settle the debt." This is probably correct, in theory,  but hinges on a calm and rational backing out of the EU with fair and rational debt consolidation in a gentlemanly manner. Paper assets held by British banks would not be worth much in a general default among EZ members.  Chaos would rein based on what we saw in Greece, Cyprus, now Slovenia, etc.  Since the Brits are considered traitors for ignoring the splendor of the euro many members might just refuse to honor their debts in British banks and elsewhere. 

bill40: Liam, You are very diplomatic so I'll say out loud what I think you wanted to say. None of the 80 recommendations are going to be implemented and nothing at all is going to change. The title is a giveaway, you always put the opposite of what you intend in the title. I am fed up of hearing the City described as world class. In fraud, tax evasion, money laundering and insanely lax regulation then yes. The whole world uses London to do it's dirty work. It's not only leverage that's the problem, there are no limits at all on hypothecation so God knows how many times over assets are pledged. Still think all those deriatives  net to zero? The next crash is already on the way and it's the ETFs that will cause it. Given the correction coming in the bond markets it's inevitable. http://www.golemxiv.co.uk/2013/06/etfs-a-warning/

silentplanet: not true at all and if you could forecast the next crash you would be richer than well anybody ?

bill40: silent, I have neither the capital, connections or platform to make a prediction of when. But I have told you what and how, don't forget that.

henrikthegreat: The UK is a country in denial…the only thing the UK does to world class level is debt. We are in awe to a Ponzi scheme housing market and a  smoke and mirrors finance industry…   The media is dumbed down to the level of a 15 year old teenager,…the elite of our country have been given carte blanche ( by voter apathy and general public disinterest ) to feather their own nests and they have, not surprisingly, stuffed and shafted all and sundry in the process.   And all this will continue, as Liam says time and time again, until the bankers are brought under control…   The bankers, however, have got the politicos in their pocket so nothing will happen there…  Meanwhile we all find our standard of living is reducing and our kids cannot get jobs and are looking like they will stay at home with us  until they are middle aged and we are old…they cannot get jobs, buy a house or even rent. That is the state of Britain 2013…and unless we get a grip of the situation this looks like a long battle.

chan:  Hendrikthegreat, Excellent summation. However, "getting a grip" on the situation is no longer an option. The "long battle" that you envisage has already been lost. We allowed feminism to control our education system, and as such our schools and universities have produced nothing but Saps and Pansies for the past 20yrs. We now no longer have a labour force capable of working and producing. It's "Game Over", for the UK.

danielphilippart: Is there no MP who will stand up to the banks and champion the cause for the separation of retail and investment banking?

ceekay: No

faustiesblog: They're probably all worrying about what GCHQ has on them.  In a sense, the NSA / GCHQ spying scandal might make for more compliant MPs. The stakes are high.  I'd put nothing past the sinister forces that slither in the echelons of power. Liam says: "It is to be welcomed, then, that the commission called for politicians to “relinquish control over decisions over the leverage ratio” arguing that “such matters are for regulators”." That's a terrible idea, Liam. Ask yourself which regulators have been found to be fit for purpose, in recent years.  I can't think of one.  The problem with regulators, or QUANGOs, is that they're stuffed full of cronies who know where the bodies are buried - and we cannot hold them to account.  They have power without responsibility or accountability.

stanilic: The need for fundamental reform of too big to fail banks has been with us now for four years but nobody seems prepared to tackle it. What are they scared of? If these fundamental reforms, which have to include a formal and complete separation of retail from investment banking, are not forthcoming they will be after the next crash which may be closer than we think.

peter63: I fancy the only real correction will come when the enormous over-indebtedness of governments and banks everywhere is no longer deferrable by one dodgy method and another; and it all crashes - with no banks and no currencies left which are not drowning. Even an ideally-framed Glass-Steagall type separation of investment and commercial banking, long and rightly advocated by Mr Halligan, would of itself be circumvented by modern decadence and corruption. The human survivors of the Cataclysm will then have to rebuild an economy, nation and worldwide, from scratch ["in return for these three portions of beans, will you hand me a chicken leg and some kindling?"]; and will do so in a gigantically chastened frame of mind.    (Recall how devoutly the Germans embraced fiscal discipline in the long decades after the Weimar hyperinflation of 1923-24.   It will be like that in the DNA of humankind - in spades - but not TILL the cataclysm!)

silentplanet: silly to make comments like this ? 

peter63: Why 'silly', silentplanet? Do you believe that governments can control the Giant Debts by massaging them with desperate measures like QE               indefinitely? The UK STILL borrows one pound in every four it spends on public account.   Will the tomorrow never come in which its  finances are downgraded to sub-junk status? The more that people in public fora look the facts in the face, the likelier one of two consequences follows.   Either politicians at last start talking to electorates about the realities of the situation and in turn are empowered to get a grip on them; or they start, behind the scenes, preparing humane strategies for dealing with the meltdown when it occurs. Continuing to live in a fantasy world where somehow the can will supposedly be kicked down the road for ever, is unrealistic.

petergardner: Satyajit Das explains brilliantly in his book, Extreme Money, much of finance is not actually about making useful goods or providing beneficial services. Au contraire. It is about playing these useful providers of goods and services like chips at roulette, using money to make more money. When financier's profits fall they too often rip out the assets of the useful providers, thus destroying them before moving on to their next target. Until that happens profits are far higher in leveraged finance than in either manufacturing or service provision. Such financiers are, in effect, parasites on real industry. The bad debts arising from highly leveraged investments by private equity have been passed on by banks via governments to the taxpayer. Savers also are having to pay for the follies of greedy financiers and banks through QE destroying their savings. QE has cost savers far more than the hair cut in Cyprus cost depositors. Satyajit Das explains how the financialisation of companies has proceeded though banks to governments and whole economies. Britain's debts will remain a burden for generations to come. Glass - Seagal was no protection because it was either not enforced or private equity found ways round it. It is still going on. The latest government sponsored Ponzi scheme is green energy. It is far less risky for private equity than the schemes that led to the GFC. The government creates the 'demand' (scare of anthropomorphic global warming) requiring investment in industry solutions. Taxpayers are commandeered to provide the revenue streams on the investments and to pay the interest on the government's debt released as subsidies to the investments. The profits go, of course to the highly leveraged private investors. What's the useful benefit? Useless windmills and now, poisonous solar cell farms manufactured overseas and in the process releasing greenhouse gases 20,000 times more powerful than carbon dioxide. Green energy is a perfect Ponzi scheme underwritten by generations of tax payers. Sadly, the UK and other governments have joined the financiers' racket. Unless governments stop playing, the only antidote would be the infertility of the human race. I am not anti business but I am very anti parasitic finance on the backs of real industry.

ryck: The bad debts arising from highly leveraged investments by private equity have been passed on by banks via governments to the taxpayer. Savers also are having to pay for the follies of greedy financiers and banks through QE destroying their savings" The heart and soul of the Fed's reasonings in 'saving' the banks, too big to fail.

ceekay: What a a fine comment    The only bit I disagree with is Glass Stegal. It's usefulness came in stopping TBTF banks taking PE & Hedge fund type risks where the taxpayer takes the losses. There were plenty of hedge funds that went bust, losing everything in 2008, that's how capitalism should work but because of no Glass Stegal the really big players, the big gamblers got their hands on our cash and have now carried on as before. Poor risk management should be punished with bankruptcy. You are so right on Green Energy, this will probably cost us more than the crash in a couple of years.

ryck: The only bit I disagree with is Glass Stegal." GS was abandoned so the Clinton Administration could force banks to particiapte in the CRA  the Community Reinvestment Act by supplying mortgage money to people with no credit.  http://www.telegraph.co.uk/finance/comment/liamhalligan/9204702/Eurozone-crisis-roars-back-to-savage-Spain.html#comment-498350589This is from owainglyndwr1 year ago  and is worth reading in detail.

petergardner: Yes Glass Stegal did some good but it isn't perfect and more people should have gone to prison.

ryck: I hope we all recognize that it was and still is illegal for any bank to speculate or 'invest' with deposits, except for the Jon Corzine case where he apparently got away clean with stealing his customer's deposits. Thus, half,m or so, of the bank is in the check writing business and other parts are into investing with retained earnings.  IF you cut off investment with retained earnings then the banks will find ways to transfer profits to other funds like hedges or quit the business.  Thus Volker's Rule is a joke since what constitutes risk is arbitrary and some government bureaucrat will make the final  decisions in a cloud of ignorance, the only cognitive medium open to the people we hire in government. 

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