Martyn In The City

UK Financial Sector versus Manufacturing Sector: It's not a game you know

Martyn Richard Jones — Sat, 12 Jun 2010 12:44:33 GMT

The article, written by Jonathan Todd, and published on Saturday 12 June 2010, was titled "No need to choose between finance and manufacturing" with the argument "Broad-brush commitments to rebalance our economy are an incomplete response to our economic growth challenge". The following text was essentially my response.

Let’s be clear about this, the suggestion that a sector of a business should contribute a larger percent to the overall business does not, in any capitalist sense, mean necessarily that you will deliberately diminish the net contribution of other sectors, and even large corporations are fully aware of the inherent dangers of allowing the balance between lines-of-business to get out of control. On the other hand, from an Inland Revenue perspective, reducing profit in certain sectors by increasing taxation on those activities, does make a lot of sense, even if this type of policy will bring howls of anguish from certain sectors of published rather than public opinion.

Now, as far as I can see, the UK has organised itself into a corner as far as systemic economic risk is concerned. This hasn’t been caused by one party or by one sector, but part of the blame can be reasonably laid at the doors of blind-faith in neo-liberal economics. Putting aside the sound-bites of Cameron, Cable and Mandelson for one moment, they still have respectable views on what I would term the poverty of business diversity in the UK. Moreover, I think to state that a rebalancing necessarily means a diminishing of the actual contribution of the financial sector is rather a problematic argument in itself.

This is not a choice between one thing or another, but of increasing overall contribution of strategic businesses, and to control things like systemic risk and the positive implications that has on government cash flows.

Now, the problem with classifying business activities can be problematic, especially when new professions come into being, but this is not the case with any of the traditional activities, whether that is in the financial sector, manufacturing, R&D or the liberal professions, and to be quite frank, in that respect, I don’t know what the fuss is about. Some financial services organisations are purely service organisations, staffed with managers and administrators, but with not one investment adviser, banker or trader in sight, keeping, as they do, their business confined to activities such as processing subscriptions, checking paper-work, processing corporate actions, paying dividends, custody and bookkeeping.

So, all in all the argument that we have concerns and proposals based on an either/or scenarios is moot. This is just not the case, reducing the overall percentage contribution of the financial sector by boosting other sectors, i.e. manufacturing, does not diminish net contribution, per se. An asset management organisation would be incredibly foolish to create such systemic risk, so to does any government that allows the economy to be too dependent on a given sector.

As for the claim that British manufacturing isn’t declining, well, it might not be at the moment, but for those who were born in the years BT (before Thatcher) we know full well that at one time manufacturing contributed more than 40% to Britain’s wealth, and now it stands at half of that. I don’t know what they teach at schools these days, but a 50% drop does seem a tad like a decline, even given the prevailing FX advantages now available.

So, should Cameron, Cable and even Mandelson be concerned about the under investment in British manufacturing? Absolutely! Not only that, they should actually do something about it. One of the first steps I would take would be to take the nationalised banking assets and turn them into full-blown Industrial Investment Banks, the second thing I would do is to create additional tax advantages and protection mechanisms for nascent manufacturing initiatives, and thirdly, invest more in developing skills needed for innovation in manufacturing, i.e. in education.

Now, coming on to the notion that you cannot have a successful climate policy without heavy involvement of traditional institutions, focusing perhaps on CO2 trading and Alternative Energy The assertions here fly in the face of facts in the ground, and without going into lengthy detail, it is best to illustrate it with a couple of questions: E.ON, RWE and Iberdrola owe what to “heavy involvement of financial institutions”? and, what do EEX and Nordpool, for example, owe to the “heavy involvement of financial institutions”?

So yes, Cameron, Cable, Mandelson and others are essentially on sound ground when they hint that to up the overall contribution of sectors other than the financial sector is the right thing to do. It’s not a complex proposition; the secret is in the ratios, contribution and systemic risk. Britain will not force-march its way out of the financial crisis – and it is most definitely a financial crisis – by expanding the ability to open doors for each other, to the detriment of everything else. An educated and willing workforce cannot be wasted on activities that can be eventually taken off-shore; it’s just not the way to go.

The link to the article on CiF: http://www.guardian.co.uk/commentisfree/2010/jun/12/finance-manufacturing-rebalance-economy

Greed, not speed, that killed the economy.

Martyn Richard Jones — Thu, 23 Apr 2009 22:00:00 GMT

MartynInEurope

Was it speed or greed that killed the markets? The following was my response to one such claim that my argument that greed rather than speed was actually the main issue this time around:

krenjenmam wrote:

24 Apr 09, 9:08am (about 4 hours ago)
...
MartyninEurope may well think it was greed not speed that killed the economy - isn't SPC's point though, that speed (of transactions) won't help when the lunatics are running the asylum?

The following - with gramatical corrections - was my reply:

In the big picture, the speed at which transactions are processed did not overly influence the financial systems one way or another - this time. Although exchange traded securities can be bought and (frequently) sold before you can say "I changed my mind", this does not apply to all investment vehicles, such as alternative investments - where speed is still relative.

Speed of transaction processing has been a factor in previous, smaller, and well-bounded financial breakdowns, but this was not the case in this far more serious relapse in the health of financial markets and economies.

Fair Market Guesswork

Martyn Richard Jones — Sat, 21 Mar 2009 14:00:00 GMT

Fair Market Value

The following comment was written in response to the blog article Too little, too late (The suspension of fair value accounting would have been very handy a year ago, but much of the pain has already passed), written by Tetsuya Ishikawa and published on The Guardian's Comment is Free blog, on Saturday 21 March 2009.

If you work in the financial business, then you should know what Fair Market Value really means, and more importantly, what it does not mean.

Okay, so let's start with a definition. Fair Market Value is typically described as the price that an interested but not desperate buyer would be willing to pay and an interested but not desperate seller would be willing to accept on the open market assuming a reasonable period of time for an agreement to arise.

There is one major flaw with this as regards to banking and valuation. It assumes high levels of trust, honour and competence.

Fair Market Value is not about representing a known value; at best, it's an informed guess. Neither is Fair Market Value a real market value, there is no proof of its current market value, only a technical extrapolation. Neither is it intrinsically fair because it is essentially an informed guess. So apart from the words and the order in which they are used, it's almost a perfect term.

So why do people use Fair Market Value? Simply stated, it's a sleight of hand. Rather than provide dated valuations, for example, the last known Net Asset Value of positions in securities, it serves the needs of people who want today's value, whether it is realistic or not. It seems people would prefer an up to date guess than a dated price.

In the old days of Hedge Funds there was no such pressing need to provide a valuation of positions until a period of subscriptions and redemptions was reached. These days, there are many companies running many Funds of Funds (FoF), funds that invest in two or more underlying Hedge Funds, a pooled investment in Hedge Funds. These Funds of Funds want to provide a guess on current value for a number of reasons. The primary reason for this is that the purchaser of positions in FoFs is more likely to be a less sophisticated investor, with a much lower purchasing power, a lot less risk tolerant of risk, and more attracted to the warm and fuzzy feel of daily pricing. So, these Fund of Funds, rather than waiting for extended periods before a calculation of the net value of the underlying assets can be made, provide frequent conjectures about market value.

The most visible merchants of FoFs are acutely aware of the psychological needs of the small and unsophisticated investors, and know how to play their client and prospect base better than any scrap-metal merchant or used car dealer, this is reflected many times in the use of Fair Market Value.

The only fair market value is the price that you have sold at, or the intrinsic value of holding positions. The rest is just informed guesswork. Maybe it's time that terms more accurately reflected their underlying meaning, however in this day and age, term abuse as well as use of deceptive terms, is rife, in business, in politics, in the media and in academia, so the chances of winning the battle against bullshit seems very slim – and that's a guess too.

The Banking Brain Drain

Martyn Richard Jones — Tue, 17 Mar 2009 20:44:00 GMT

I would have thought that some banks would be only to glad to get shot of the holders of the "intellectual capital" that have provided the "knowledge" driving and supporting the strategies and actions that lead to such a royally screwed up economy. .... Phew!

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Capitalistan

Martyn Richard Jones — Thu, 26 Feb 2009 23:00:00 GMT

MartynInEurope

27 Feb 09, 5:39am (1 minute ago)

Before New Labour leave office, and in order to sanitise the financial markets, they could rebrand the City, I suggest a new name:

CAPITALISTAN

We Never Saw It Coming

Martyn Richard Jones — Wed, 25 Feb 2009 23:00:00 GMT

This blog post was written in response to an article which appeared on The Guardian's CiF blog site. The article, I blame the Queen for this crisis, (Ann Pettifor, The Guardian Thursday 26 February 2009). Ann wrote:

This week I was asked by the Guardian to address the Queen's question: "Why did no one see it coming?" I tried to answer the question by sharing some of the seriously flawed analysis and advice provided by orthodox economists – those that dominate both the economics profession and the economics commentariat.

Iceland is a miniscule economic guinea pig, the liberal media journos saw all of this coming, the orthodox economists didn't have a feckin clue, the bad economics commentariat (The Economist) are guilty, the OECD fiddled while Reykjavik burned, and it's all Brenda's fault.

But don't worry, some old dears who earn their daily crust from blogging and book writing will fix the world. If what they learned in A level Economics doesn't work for everything, they can always google for the answer.

I'm just so glad that all of that's been cleared up now.

Look, the Bush Administration was expressing concern about debt and credit in 2003 - yes, that's right, even those laissez faire nobs were getting all tired and emoitional about it. In 2004 I was in China working on the issues of banking credit, debt, performance and productivity. The Fed was still worried about debt and credit. In 2005 I was in Zurich and the City, again, very much concerned about mounting corporate and personal credit and debt, in 2006 in Dusseldorf and London, in 2007 in Cork and Amsterdam and Istanbul. Towards the middle of 2008 the illuminati in the mainstream quality press saw the light .. bingo.

Have people ever wondered why the likes of Max Keiser has warned about this crisis for the best part of six years, maybe more?

If you want an economic genius then don't look for one in the newspapers; journalists are almost invariably the last to know and the first to blow their own trumpet, and even then, they have to be enlightened using language that even junior George B would understand. Okay, little rant over.

Financial Crisis and Subprime

Martyn Richard Jones — Wed, 18 Feb 2009 23:00:00 GMT

Oh dear, whatever happened here? After years of over-borrowing and under-saving, the plentiful supply of cheap and easy money, the enthusiastic recklessness of a number of financial managers, and the complaisance of governments, the inevitable happened, and panic ensued.

It has not been edifying to see political leaders – people at one time we might have considered intelligent, cautious and wise human beings, falling over each other, in the courageous rush to identify scapegoats, to nationalise bad debt and to prop up failing companies.

After cursory deliberation, the condemnatory finger pointed at short sellers and Hedge Funds, and this mendacity passed by with little comment. Thankfully, the new blame game does not seek to target a conspicuous group of people, such as Swiss gnomes, which is progress of sorts, but it is still only a marginal improvement.

So, what caused the financial crisis? Superficially, the answer is simple; it has been the collapse of the subprime market and its impact on underwriters of usurious lending.

There was a time when people with bad credit ratings, or no credit ratings, would have found it difficult to obtain a high street loan to purchase a second-hand car, and would have had no chance of obtaining a mortgage. Cheap money, overvaluation and the property boom changed all of that.

Subprime allows people with dodgy credit ratings to acquire mortgages, albeit with inflated interest rates. For years, things worked quite well, as the number of people keeping up with their repayments well-exceeded analyst’s forecasts, which meant that profits from subprime lending surpassed expectations.

This led to two things: further downplaying of risk in the subprime market, and a boom in the number of banks offering subprime loans.

Traditionally, banks lent out money that they held in the form of deposits, in exchange for timely repayments. In many countries, banks were constrained by how much exposure to risk they could assume, in order to ensure solvency and liquidity; so, even when money was at its cheapest, they could not legitimately expand their subprime business beyond certain levels, without getting creative and by passing on risk to third parties.

What happened next? Just as some banks had cashed-in on insurance brokerage, some switched to the role of subprime lending matchmakers. This meant that they were able to take the upfront brokerage fees, and then pass on the loan arrangements to another financial house, and in this way, they increased their fees whilst offloading the risks inherent in holding especially risky arrangements.

Of course, the actual underwriters of these loans also wanted to reduce their risk exposure.

It is a simplistic explanation, but what these companies first did was to create a way to allow for betting on the overall performance of collections of mortgages – the fewer defaults the higher the gains, in order to allow trading in bets.

Additionally, because of the perceived low risk of subprime and the continued overvaluation of real estate, these bets came with an irresistible added value-proposition, an AAA risk rating, just like government bonds.

Then, these companies sold on slices of composite bets to other punters, charging for the betting slips based on a combination of risk, duration and return.

There are various forms of betting on subprime performance, the most common products being Collaterised Debt Obligations, Mortgage Backed Securities and Asset Backed Securities, the riskiest bits of which are toxic waste.

Now, the calculation of the value and the risks in these bets are horribly complex, and frequently inaccurate. So, just to push the envelope, some people came up with a way to take a bunch of already complex pooled bets, and to create a mega pool of pooled bets, which they would then sell on to the market, as another investment product.

So, when economies tanked, it was the subprime market, mainly in the USA, that took the hit for the increase in the defaults on loan repayments. Worse still, because the holders of these bets could not honestly state either their riskiness or actual value, they became as desirable as financial crap, which meant that other banks were no longer prepared to lend them money, and for Prime Brokers to be denied loans, is like turning off their life support?

As attractive as schadenfreundin might be, letting Prime Brokers go to the wall is not a sensible option, as the survival of other companies and many jobs are also at stake.

The subprime downturn led to the current predicament, but that is not where it started, preceded as it was by the follies and frauds of the dot com era, the artificial “good times” brought on by government overinvestment in the military industrial complex and the costs of war and occupation.

We are where we are mainly because of one thing, decades of government, corporate and personal imprudence.

Short Termitis and the Bonus Culture

Martyn Richard Jones — Wed, 18 Feb 2009 23:00:00 GMT

Short Termism is an accusation aimed at the financial institutions and is directed towards their short-term expectations of the companies that they finance; we know that, we have known that for years.

The virus of short termitis is all-pervasive in the USA, the UK has embraced and modified this myopic and short-term culture in many aspects of society, including financial services, telecoms, and even more importantly, government and opposition. This Short Termism in the UK has been prevalent since the early eighties, and some people think that this is one reason why countries like Germany and Japan have left the UK in the dust, relatively speaking.

However, to pretend that Short Termism is simply linked to the bonus culture is a big mistake. Which came first, the Short Termism or the Bonuses?

For example, this increasing focus on short term metrics is a proxy for a short-term focus. What does this mean? Corporations have developed the habit of making short term projections on growth in order to stimulate investment. If companies hit those short term targets, and visibly demonstrate short term improvements, then those people will get rewarded (over compensated), if not, the very same people could find themselves looking for work elsewhere. The other problem is short term stock speculation investments and longer term institutional investments, neither of these groups typically has any interest in the companies they buy shares in, other than short term performance. Added to this is the very short term behavior of hedge funds and private equity firms, who are not the prime culprits, but passively encourage the large banks to copy their short term strategies, which results in more short termitis and massive systemic risk.

I know many people will not like this, and will put it down to some lefty delusion, but the problems of short termitis reflect the fundamental problems of capitalism. For capitalism to work it requires companies, governments and countries to crash and burn from time to time.

Simply stated, short termitis affects the performance of corporations, it influences the competitiveness and growth of economies, and it skews investor returns. When investors become stakeholders, and speculation is discouraged through financial penalties, then investors themselves can limit the bonus culture. Warren Buffet knows a thing or two about this.

See also: A short-term bonus plan,Tetsuya Ishikawa,guardian.co.uk, Thursday 19 February 2009 11.30 GMT