19 June 2009

Mervyn King Seems to Get It

The more I listen Mervyn King, the more I get the impression that, as Governor of the Bank of England, he's had a reasonable understanding of the situation he's been faced with, but little real influence. One of his recent speeches has a lot of value in it[1]. Early on in the speech he highlights an effect of the current climate which, although it may have some negative elements, I generally think is quite positive.

Investors continue to demand high returns to finance banks. Put bluntly, market data on credit spreads imply that some banks are viewed as a worse credit risk than some of their customers. As a result, companies that can bypass the banks to access capital markets directly are doing so. Indeed, in the first four months of this year, more finance was raised in debt and equity markets than is normally the case in an entire year.

In this context, banks are risk externalisers; when somebody with money invests it directly in a business, they do so with an understanding that, if the business fails, they stand to lose some or all of their investment. When a bank acts as a middleman in that transaction, the person lending the money will often have an expectation that a proportion of their money is guaranteed to be safe, so the risks will be the same, but rather than the lender shouldering all the risk, it is shared by the lender and the taxpayer, who has to underwrite the guarantee. In that context, a shift towards direct investment is a positive thing as it internalises the risk, rather than socialising it.

King seems prepared to cut to the chase when it comes to national debt.

But five years from now national debt, as a proportion of national income, is expected to be more than double its level before the crisis. So it is also necessary to produce a clear plan to show how prospective deficits will be reduced during the next Parliament, so returning to a gradually declining path for the ratio of national debt to national income.

It's on the issue of banking regulation that he really hits his stride.

If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big. It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure. Something must give.

That sounds perfectly sound to me. I'm not keen on the idea of state guarantees generally, but if they exist, it seems especially unwise to offer them to the riskiest institutions. The frustrating thing is that the actions of the government have often run in the opposite direction to King's comments, encouraging the merger of Lloyds and HBOS being the prime example. Facilitating consolidation at the same time as bailing out banks because of their size displays ridiculously short term thinking, especially in an industry where the barriers to entry are so high.

Either those guarantees to retail depositors should be limited to banks that make a narrower range of investments

That sounds reasonable enough; if you want an extensive guarantee, then in return, you have to show that you're restraining your risk. That's what I'd expect from any other insurance policy.

or banks which pose greater risks to taxpayers and the economy in the event of failure should face higher capital requirements

Again, that's reasonable enough, although the caveat is that rapidly increasing capital requirements can increase the immediate demands on banks and damage their stability.

or we must develop resolution powers such that large and complex financial institutions can be wound down in an orderly manner.

This is where I think he really hits the nail on the head and it's something he expands on later in the speech.

One important practical step would be to require any regulated bank itself to produce a plan for an orderly wind down of its activities. That would provide the information to the authorities the absence of which made past decisions about the future of institutions difficult. Making a will should be as much a part of good housekeeping for banks as it is for the rest of us.

Attempting to completely prevent the failure of banks will always prove futile, so as a strategy it can never be more than a damage limitation exercise. The real need isn't to prevent failure, but to ensure any failure is orderly. Banks can happily be left to fail, so long as they don't end up externalising costs in the process. "Too big to fail" seems too sweeping a statement to explain the situation. "Too big to collapse" would probably be more accurate.

The one point at which King seems to understate the situation is:

Privately owned and managed institutions that are too big to fail sit oddly with a market economy.

I wouldn't say they sit oddly with a market economy, but that they are completely incompatible with a market economy. The strength of true market economies is that they evolve. The businesses which satisfy the demands of customers most effectively tend to succeed and those which don't fail. In that way, bad practices get forced out and good practices thrive. Like biological evolution, it may not be a completely smooth process, but it is effective. Guaranteeing the survival of a bank, no matter how unfit for purpose it is, stifles that process of evolution and begins to introduce some of the characteristics which make command economies so unresponsive.

1.
http://www.bankofengland.co.uk/publications/speeches/2009/speech394.pdf

18 June 2009

Copyright in Digital Britain

As is often the case with government documents, the tone of the copyright section in the Digital Britain report reveals more than the substance. Given the collapse of the attempt to introduce a "three-strikes" law in France [1], it was unlikely that a similar approach would be suggested. What has been proposed amounts to carrying on with the law pretty much as it is and doing something else, unspecified at this point, if copyright infringement doesn't reduce within a year. In contrast to the relatively bland proposals, the language is in places emotive and weighted, such as:

The Government considers online piracy to be a serious offence. [2]

Aside from the fact that the use of the word "piracy" to describe copyright infringement comes across as puerile in a government publication, the sentiment appears to be at odds with the public mood. Copyright provokes a range of opinions; some view it as an illegitimate state granted privilege, some view it as an expedient state mediated bargain and some view it as a legitimate property right. However, outside of a relatively narrow set of lobbying groups, I know of few people who would consider copyright infringement to be a serious offence. In fact, I think you'd struggle to find many people who would consider it to be anything more than a relatively minor misdemeanour.

By pushing so heavily against the general mood, the government threatens to achieve the opposite of what it is aiming for. On a party political front, the success of the Pirate Party in Sweden shows what can happen when a government enacts draconian laws, even when the issue is one which is rarely at the forefront when it comes to election time. Outside electoral politics, the effect can be even more profound. It might be an unpleasant thought for authoritarian politicians, but it is customs and social norms which tend to define what is socially acceptable, rather than the force of law. In the long run, it tends to be custom which over-rides law, rather than the other way around. Legal brute force is a highly inefficient means of changing behaviour; it might be effective at guiding people in a slightly different direction to the one they're moving in, but if it's used to push the mass of people in a direction they don't wish to go, it will tend to break down.

In terms of copyright, a general disregard for the law is already in evidence. Under UK law, ripping a CD and putting it onto an MP3 player is prohibited, but I know of no-one who has any respect for that law. Of course, many will be unaware that the law exists, but even when people become aware of it, I've seen no evidence that their behaviour changes one iota. It's a clear example that even people who would ordinarily consider themselves "law-abiding" are prepared to ignore laws if they view them as outdated, pointless or stupid.

By describing online copyright infringement as a serious offence and retaining copyright laws that the general public clearly has no respect for, the government risks pushing copyright into the same category as the requirement that London Hackney Carriages must carry a bale of hay and a sack of oats or the requirement that all men in England must carry out longbow practice - laws which still sit on the statue books, but are regarded as amusing historical anomalies which don't need to be observed.

1. http://news.bbc.co.uk/1/hi/technology/8093920.stm
2. http://www.culture.gov.uk/images/publications/chpt4_digitalbritain-finalreport-jun09.pdf section 18.

17 June 2009

It Wasn't Me Guv

From the BBC:

Chancellor Alistair Darling does not plan fundamental reform of the way UK financial institutions are regulated.

Mr Darling has said that the current regulatory system is not to blame for the credit crunch, blaming instead the bosses of financial institutions."
[1]

I find that utterly pathetic. Setting up a regulatory regime to prevent a set of events and then claiming that the regulatory regime is not at fault when one of the most severe of those events occurs is responsibility dodging of the highest order.

Regulation creates deadweight losses and distortions. Regulation will tend to make people believe that an activity is less risky and therefore encourage participants to take more risks. If the regulation is ineffective at controlling risk, which seems to be the admission in this case, then it can end up being seriously counter-productive and in that case, if you aren't prepared to amend it, you should seriously consider getting rid of it.

1. http://news.bbc.co.uk/1/hi/business/8104340.stm

08 June 2009

Electoral Vagaries

Looking at the press coverage of the BNP’s success in getting an MEP elected in the North West region, you’d think that they’d managed to attract a huge number of new supporters. The numbers tell a different story. Rather than being the beneficiaries of a wave of support, the BNP actually got fewer votes in 2009 than they did in 2004 (132,094 compared to 134,959 [1],[2]). The only parties to increase their total number of votes in the region were UKIP, the Greens and the English Democrats. So, how did fewer votes result in a seat being won? There are a few contributory factors:

By far the biggest factor appears to be the collapse of the Labour vote, plummeting from 576,388 to 336,831. The seat that the BNP gained was matched by a seat that Labour lost, so it seems that rather than the BNP actively winning the seat, it was lost by Labour and trickled down to the fifth place party.

Another change is the absence of the Liberal Party, which gained 96,325 votes in 2004. The party was formed by members of the original Liberal Party who objected to the merger with the SDP. The party has traditionally had strong core support in Liverpool and is moderately Eurosceptic. Given that the Lib Dems’ vote numbers dropped, it’s not clear where the Liberal Party votes went.

A further factor is the emergence of new parties which spread much of the vote. Had the Socialist Labour Party not stood, I suspect that enough of its vote would have gone to the Green Party to enable them to finish ahead of the BNP.

All in all, I don't think that the result should be viewed as a sign of progress for the BNP. The reality is that the traditional big three and the BNP got fewer votes than last time, while everybody else got more; the BNP gained a seat purely because they are losing support at a slower rate than the big three. I suspect the damage to the big three is a combination of the expenses scandal and an increasing familiarity with the list system used in European Elections, which is giving people more of a sense that a vote outside the big three is not a wasted vote. The fact that the BNP couldn't increase their vote when there is a recession and disenchantment with the political mainstream is so high tends to make me conclude that this isn't a watershed moment for the BNP. In fact, I feel it’s the opposite, as it’s shown that the BNP have no appeal outside their core vote.

This election provides clear evidence that, when voters become unhappy with their usual mainstream choice, they might not bother voting, or they might decide to vote for a smaller party, but what they won’t do is vote BNP.

1.
http://news.bbc.co.uk/1/shared/bsp/hi/elections/euro/09/html/ukregion_34.stm
2. http://news.bbc.co.uk/1/shared/bsp/hi/vote2004/euro_uk/html/34.stm