jka on economics UK

Mary Poppins and the UK banking crisis

It had never occurred to me the Wizard of Oz was an allegory for the US depression of the 1930’s. The yellow brick road a reference to the Gold Standard, the scarecrow representative of plight of the US farmers and more. Imagine how surprised then to realise Mary Poppins was a prophetic allegory of the UK Banking crisis of 2008.

It really should have been obvious. The script included a run on the bank, lots of kite flying, the bottomless carpet bag, the credit crunch explosion from the fireworks of Admiral Boom, a run on the bank. It really is all there.

The film begins with the young and pretty Mary Poppins perched on a cloud high above London in Spring 1910 observing events below. Mary Poppins is the Chancellor of the Exchequer.  The action descends to earth where Bert, a cockney jack-of-all-trades is performing as a one-man band at the park entrance. After the end of the show, he strolls down the street and introduces the audience to the well-to-do, but troubled, Banks family. (Bert the cockney chimney sweep obviously the Treasury.)

The Banks family is the British banking system headed by the cold and aloof Mr. Banks, who has formed the idea that a British household ought to be run with the strict authority of a British bank. [A clear reference to moral hazard]. Mr Banks is the Bank of England or the Governor of the Bank of England himself. His wife is the loving and spirited but highly distracted suffragette Mrs. Banks, (the FSA).

As the script develops, the Banks' latest nanny quits out of exasperation after the Banks' children, Jane and Michael run off in pursuit of a wayward kite. The Banks' latest nanny is the FSA supervisor, the kite flying an obvious reference to off balance sheet activity relating to highly leveraged transactions, sub prime debt, CDO's, SIV’s, toxic debt etc.

The bank crisis develops as Michael one of the Banks' siblings refuses to deposit his tuppence with the Dawes bank, a misunderstanding develops and a run on the bank ensues. Obviously the Dawes bank is Northern rock, the tuppence, wholesale funding and Michael and Jane representative of the major clearers.   

Pyrothecnics ensue as the fireworks from Admiral Boom explode above the roof tops of London. The reference to Boom and bust so obvious, the credit crunch impacts, I can’t believe I missed this.    

The crisis abates as Michael puts his tuppence into Northern Rock, Mary Poppins uses her bottomless carpet bag to inject liquidity into the system and re-capitalise the Banks family.

In the film, the next morning, the winds have changed direction, and so Mary must depart. Mr. Banks, now loving and joyful, reappears with the now-mended kite and cheerfully summons his children. The greatly-relieved Mrs. Banks supplies a tail for the kite, using one of her suffragette ribbons. In the park with the children and other kite-flyers, Mr. Banks meets Mr. Dawes Jr.. Mary Poppins her work now done, takes to the air with a fond farewell from Bert.

So there you have it. It’s all going to be OK.

[some script extracts from Wikepedia ]

UK Libor spread falls to 98 basis points

UK Libor - base rate spreads narrowed to 98 basis points this week, the lowest levels since late September and below the peak of 180 basis points, mid October.

Libor is a measure of liquidity in the system rather than associated risk of borrowing. Banks are loathe to lend because of lack of funds rather than risk of default. An modest premium to yield would never compensate for a default on capital.

In 2007, spreads increased to over 100 basis points as the liquidity crisis hit the system. They peaked again at the end of December as banks held cash to dress the balance sheets for the year end.

Rates will remain high until the end of December as banks hoard cash for the year end before falling in the New Year to around a 50 basis points premium.

Elsewhere in the banking sector, the Government will hold a near 60 per cent stake in Royal Bank of Scotland (RBS) after investors rejected the bank’s £15 billion rights issue. Just 0.24 per cent of the new shares offered to investors were taken up, leaving the Government with the balance.

The rights issue was offered at 65.5 per share. RBS shares closed at 55p last night, an underwater rights issue is never a good sign, nevertheless a 99.75% rejection is pretty comprehensive rejection.

It doesn’t augur well for Lloyds TSB and Halifax Bank of Scotland, will also ask shareholders to buy £13 billion of new shares in offers underwritten by the taxpayer in the coming weeks.

UK economy falls by 0.5% in the third quarter

Gross Domestic Product (GDP) contracted by 0.5 per cent in the third quarter of 2008, compared to flat growth of 0.0 per cent in the previous quarter. The level of GDP is now 0.3 per cent higher than the third quarter of 2007.

The output of the production industries fell 1.1 per cent, driven by a fall of 1.3 per cent in manufacturing. Output of services fell by 0.4 per cent. The decline was most significant in distribution and business services.

Household expenditure fell 0.2 per cent. The biggest movement was in transport, where purchases of motor vehicles fell markedly according to the ONS.

Government final consumption rose by 1.0 per cent and is now 2.7 per cent higher than the third quarter of 2007.

Gross fixed capital formation fell 2.4 per cent and is now 5.4 per cent below the third quarter of 2007. Most notable, were falls in investment on new dwellings and spending related to house purchases.

Both the fall in GDP and investment are consistent with our previous patterns for recession and investment slump. Recession - what shape are we in? : UK investment set for a long slowdown.

UK retail sales - carnage in the high street

It’s carnage in the high street as MFI and Woolworths are placed into administration.

The collapse of Woolworths could lead to a "price war" as the administrators slash prices to generate cash.. Twenty thousand jobs could be put at risk at the Woolworths high street chain.

Currys and PC world became the latest high street names to confirm the dramatic slump in retail spending. DSG International owners of the two stores, said comparable sales for the 24 weeks to October were down 7% at Currys and 11% at PC World. DSG warned that the trading environment remains "tough and volatile" and the outlook for the peak Christmas period and 2009 is "uncertain".

Kingfisher, owner of the DIY store chain B&Q, said like-for-like sales in its UK stores were down 9.2%. Demand for more expensive items such as kitchens and bathrooms were particularly badly hit.

John Lewis Partnership has reported sales down by 14% week on week during November. It is clear, housing related and big ticket retail items are taking the hit.

Officially, retail sales in October according to the Office for National Statistics were up by 2%. The stats looked a bit "toppy". It will be interesting to see, the formal data for November in due course.

Against this trading background, the 2.5% reduction in VAT could be as effective as King Canute on the beach.

UK Investment - set for a long slow down

Investment, UK set for a long slow down.
In the second quarter of 2008, Investment defined as gross fixed capital formation fell by 2.1% after a first quarter increase of 0.27%.

In our graphic we compare the previous two recession cycles of 1980 and 1990. The 1980 recession saw a large loss of manufacturing capacity and jobs. Investment fell for seven successive quarters, peaking at 10% and 13% in the third and fourth quarters of the slow down.

In 1990, the down turn was not as severe but was certainly more protracted. Peaking at just under 10%, the UK experienced ten quarters of negative growth. This time, it's a little too early to speculate but a re-run on the 1990 pattern looks a fair bet.

Governor warns banks must lend, Treasury is warned they can't

Mervyn King has warned the UK economy will experience a protracted downturn if the commercial banks don't resume normal lending level.

Blimey, it was only yesterday, the Chancellor said we were going to have a short recession and a quick recovery.

Speaking to the Treasury Select Committee, the Governor of the Bank of England said.

"The most pressing issue is to ensure that normal bank lending is resumed. Without that the down turn in activity could become extremely protracted and extremely damaging."

"These are exceptional and difficult times, the financial crisis is affecting every family and business in the country. It also poses great challenges to policy makers around the world".

"A continuing failure of banks to lend could lead to a damaging deflationary spiral as the economy continued to shrink while inflation tumbled".

“Banks are giving up profitable lending opportunity in order to behave defensively and reduce the size of their balance sheet. Individually, that makes sense for a bank to pay them that way," he said.

"Collectively that makes no sense at all because if all banks behave in that way, then the economy will go into a steep recession and the banks will themselves see bigger losses on pre-existing loans.”

He said the government "may have to intervene directly" to ensure the banks start to increase their lending.

Only yesterday Sir James Crosby, explained the banks are faced with a massive £160bn of redemptions over the next three years. With little prospect of wholesale funding this will lead to a contraction in the loan books.

“The banking sector is shell shocked, most banks will be focussed on strengthening their balance sheets In such an environment, there are very few banks with the capacity to increase lending.”

This in a report to the Treasury . Someone should ensure a copy is sent to the Governor.

UK housing - Net New mortgage lending to fall in 2009.

Net new mortgage lending is likely to fall to less than zero next year, according to a report commissioned by the Treasury from Sir James Crosby, the former chief executive of HBOS, owner of the Halifax.

Sir James is warning that as homeowners are paying off mortgages, banks are putting less money back into the housing market than they are taking out.  New net mortgage lending is very likely to fall below zero in 2009 (compared to around £40 billion this year and £108 billion in 2007) with only a modest recovery likely in 2010.

The inability to refinance existing mortgage-backed funding and the continuing pressures in wholesale funding markets which is really hitting the banks' capacity to make new loans.

Mortgage lenders will have to live with little or no access to asset-backed funding through 2008 to 2010, together with having to cope with in excess of £160 billion of redemptions of existing paper over the same period.

“The banking sector is shell shocked, most banks will be focussed on strengthening their balance sheets In such an environment, there are very few banks with the capacity to increase lending.”

In the longer term, therefore, the UK mortgage market is expected to revert to a structure where lenders fund their lending more directly from deposit gathering.

“There is no doubt that extremely well capitalised banks that are supremely confident of their access to affordably priced funding will eventually lend more freely. But it will be some time before this is the case in the UK.”

Final report submitted 24 November 2008.

Pre Budget report - VAT cuts and consumer spending

“To deliver a much-needed extra injection of spending into the economy right now. I therefore propose to cut VAT from 17.5 to 15 per cent until the end of next year.” So spoke Chancellor Darling in the Pre Budget Report.

But will a 2.5 percentage point cut in VAT make any difference to people’s spending decisions? right now. Nick Clegg, the Liberal Democrat leader asks will a modest price cut persuade the consumer to buy a flat screen TV? Or many other products for that matter.

At a time when retailers are slashing prices by 20% and more to stimulate sales can a 2% cut create a much needed “injection of spending”.

The Treasury figures suggest the cut is worth £3.8bn in the current financial year, perhaps worth around £1.5bn in December. It doesn’t sound like much “right now”.

David Smith Economics Editor of the Sunday Times, argues, “the effect of the VAT cut, if there is one, is cumulative. Along with sharply falling inflation, it will mean, according to the Treasury, that real household disposable income growth stays positive next year, if only by 0.5% to 1%. That is still consistent, it believes, with a fall in consumer spending of 1% or more, and a rise in the saving ratio.”

This may well be but with low levels of housing activity, housing equity withdrawal, worth some 5.7% and 4.6% of post tax income in 2006 and 2007 will be very low into 2009.

Rising unemployment, falling house prices, credit restrictions, the spectre of higher taxes and NI payments in the near term will inhibit consumer expenditure. Lower interest rates will help and along with the VAT reduction is welcome. But can it be enough to see a quick bounce back in the economy in the second half of 2009, let alone right now?

Chancellor Darling gives the UK a V shaped recession

The down turn will be quickly reversed, it's going to be a V shaped recession according to Chancellor Darling and the November pre budget report. The fiscal stimulus will cost £20 billion this year and next. VAT reduction means a boost to the economy of £3.8bn in 2008/9 and £8.6bn in 2009/10. The down turn will be quickly reversed, it’s going to be a V shaped recession. It's all going to be OK.

UK GDP is expected to be 0.75 per cent in 2008 as the economy contracts in the second half of the year. The recession is forecast to continue into the first half of 2009, with GDP contracting by –1.25 to –0.75 per cent in the year as a whole. Thereafter growth is forecast to recover to 1.5 to 2 per cent in 2010 and 2.75 to 3.25 per cent in 2011. The lagged effects of monetary and fiscal stimulus, lower commodity prices, sterling's depreciation, normalised credit conditions are expected to boost growth. Unemployment is expected to rise from 0.98 million to 1.41 million at the end of 2009 and to 1.55 million at the end of 2010 based on the average of independent forecasts.

CPI inflation is set to fall sharply in 2009 as the inflationary pressure from global commodity prices reverses, below trend output exerts downward pressure on domestically generated inflation and the temporary cut in the VAT rate is passed through to consumers. Inflation is expected to fall to 0.5% in 2009. Thereafter inflation returns close to its 2 per cent inflation target. RPI will be negative.

Public sector net borrowing (PSNB) is projected to increase to 5.3 per cent of GDP in 2008-09 and then to 8.0 per cent in 2009-10, as the economic downturn reduces tax receipts, the automatic stabilisers (shouldn't this be de- stabilisers) increase spending, and borrowing rises to finance the temporary fiscal action to support the economy.

Borrowing is expected to reach £78 billion next year and rise to £118 billion, which is equal to 8 per cent of GDP. It is expected to fall back to £54 billion before balancing out in 2015-2016.

So there you have it. I's all going to be OK after all. No soft landing but a quick bounce back.

Comment: It sounded a bit to good to be true but then JimH has a great offer from NIgeria, which appears to be on the money. No bank details provided.

Where next for oil prices? The speculative bubble map.

Oil prices Brent Crude basis were trading at just under $150 per barrel in July. Any number of explanations were put forward as the market peaked.

Concerns over supply as the Middle East tensions were enhanced, Israel attacking Hezbollah, the Iranian unranium programme, the threat of a US attack, Iranian retaliation, hurricane season in the Gulf of Mexico, hot summers, mild winters, low stocks. Surging demand in China, loss of supply in Alaska as the BP oilfield at Prudhoe was closed. Speculators were talking of $200 as the next hurdle rate to beat.

Since then the oil price has collapsed below $60. Falling demand, oversupply and peace in the Middle East the explanation. The reality is the oil market has experienced the classic speculative bubble  mapped exquisitely by Jean-Paul Rodrigue of Hofstra University.*

The Rodrigue chart identifies the four phases of the speculative bubble, stealth, awareness, mania and blow off. In our chart we have mapped the oil price, Brent crude basis from 2004 against the bubble map. The build and blow phases are evident but there is some suggestion of a rally to a $60 pb norm into 2009.

*"I composed the chart about 4 years ago to explain my students the mess we were heading for. I remember seeing a chart of low graphic quality posted on a blog (which then disappeared) that depicted the stages in a financial mania but could not identify its source. Posted the chart I composed on my "blog" and to my surprise it was picked up and used all over without me being aware of it."

For a copy of the bubble chart- e-mail jka