Vickers report: don’t kill the goose that lays the golden egg!

David Cowan 10.26am

The coalition’s response to the Vickers report was a missed opportunity. A chance to reform Britain’s banking sector for the better has been hijacked by the Liberal Democrats’ yearning for influence. And so George Osborne has accepted the report in full, though it couldn’t be said totally against his own judgement.

The most flawed ‘reform’ is the ring-fencing of banks’ investment and retail arms by legal firewalls. This policy is based on the fallacy that so-called ‘casino banking’ in banks’ investment arms put retail customers at risk. This simply does not add up when one considers the fact that Lehman Brothers did not have a retail arm and Northern Rock did not have an investment arm. Yet both collapsed. Spectacularly so. The truth is that there is always risk in banking, whether you are dealing with CDOs or straightforward home loans.

Large retail banks will be forced to have capital equal to 17 per cent of their assets, which is well above the 7 per cent required in Basel III. While it is certainly desirable that banks recapitalise, this requirement is superfluous. Equity capital is already being over-taxed, in particular at a time when Mr Osborne insists on arbitrarily increasing the bank levy without a moment’s notice. Decreasing the tax burden would be a more effective policy than enforcing new regulations. Remember too that Lehman Brothers and Northern Rock did not have a problem with insufficient capital. Yet still they collapsed.

A compulsory recapitalisation of the banks also does not make sense at a time when the Treasury is putting so much pressure on them to lend more. Project Merlin, QE2 and a bank rate at 0.5 per cent form the bedrock of Mr Osborne’s plan for growth: in other words, cheap credit. The Chancellor has two choices: solvent banks and low inflation, or an inflationary credit bubble. Which to choose? One hopes the former.

The overall effect of these reforms will be damaging. This is widely recognised. PricewaterhouseCoopers (PwC) has estimated that the total cost of these proposals to the banking sector could be as much as £12 billion. With an EU-wide Tobin Tax and new regulations on the way from the European Commission it is now increasingly likely that some banks will move their headquarters eastwards and out of Britain. Boris Johnson has rightly said that the government must not “kill the goose” that created £63 billion in tax revenue last year.

These reforms will create an overly capitalised and retail dominated banking sector that may struggle to compete in the global financial markets. This can only perpetuate the present situation in which our banking sector is dominated by four banks. Instead of trying to make sure banks never fail the coalition should try to ensure that banks are not too big to fail and can fail safely. The way to achieve this is to have greater competition.

In this sense there is some hope in Mr Osborne’s acceptance of a Redirection Service, which would allow bank accounts to follow customers when they switch. The privatisation of the state-owned banks, with the sale of Northern Rock to Virgin Money for £747 million, and the sale of 632 branches of Lloyds Banking Group to the Co-operative Group, will also help to create a more diverse banking sector. It is important that as well as getting a good deal for the taxpayer that George Osborne can use the privatisation of the banks to make the sector more competitive.

Next year’s Financial Services Bill could be the Chancellor’s second chance to reform the banking sector effectively, with the abolition of the Financial Services Authority and the transfer of its powers to three new Bank of England bodies.

The new Financial Policy Committee should be able to focus on establishing a regulatory framework within which it is compulsory for large banks to deliver credible plans - or ‘living wills’ - for rolling up operations in the event of collapse.

The ring-fencing of investment and retail arms of banks and compulsory capital requirements could be used as ‘sanctions’ against banks which fail to provide a credible plan, rather than being a universal regulatory blueprint.

This would ensure that Britain’s banking sector remains a competitive and productive industry and does not pose a severe threat to the rest of the economy or to the taxpayer. It’s about time George Osborne listened to Boris Johnson and not kill the goose that lays the golden egg.

Follow David on Twitter @david_cowan

While the Euro remains on life support, it’s business as usual for the City

Daniel Cowdrill 10.04am

Listening to David Cameron’s opponents during the weekend, you would think his veto signals the end of civilisation - or at least the UK’s participation in it.

One of their scare stories is that the City of London is worse-off than before the EU summit. In reality, however, it is in much the same position.

The sticking point was the financial transaction tax (FTT). This is a tax on every sale or purchase of stocks and bonds or other financial products by banks. On these pages, Craig has dismissed a FTT as an unhelpful ‘soundbite tax’, while Alex described it as ‘misguided’. Elsewhere, Sir John Major has labelled it a ‘heat-seeking missile aimed at the City of London’.

As 75 per cent of the EU’s financial services industry is located within the City of London the burden of this tax would fall disproportionately on the UK economy and the two million people who are employed in financial services in this country.

Unfortunately, France was not willing to listen to British demands. President Sarkozy’s refusal to concede led to a fiscal ‘pact’ rather than the fiscal union the markets had desired. What is set to be agreed over the coming months without the UK is unlikely to be enough to stop the deterioration of the European debt crisis, and President Sarkozy won’t be so ‘heartened’ if (or when?) France’s credit rating is downgraded.

However, beyond all this the fundamentals remain the same for the City. The UK remains part of a single market that allows the (reasonably) free movement of people, capital and services across a trading block of 500 million people. The City will continue to benefit from the single market - Mr Cameron’s veto does nothing to alter this.

To be sure, it could be argued that the new 17+ euro block will foist regulations on the City when Qualified Majority Voting (QMV) is introduced in 2014. But these are future deals that are yet to be negotiated and agreed. When the time comes there is no reason why Britain can’t win support and obstruct the worst that might come our way.

In any case, there are some people who believe that had the UK not vetoed the new treaty the French would be less determined to impose other regulations on the City. This thinking is deluded. French dirigiste tendencies have been strengthened by a financial crisis that many in France perceive as the fault of speculators in the City of London. This isn’t going to change no matter how much sovereignty we sign away.

Furthermore, access to the single market is not the only thing that attracts business to the City. In the 1980s the ‘Big Bang’ attracted financial services to London from all over the globe, not just Europe.

The UK’s competitive regulatory and tax framework continues to attract financial services to these shores. We are also near the main European continent and, of course, we speak English. Even the EU tends to deliberate great matters in English - now the global lingua franca (such irony might be lost on the French).

The City will live to fight another day. The euro, on the other hand, may not.

Could this be the beginning of the end for Britain in the EU?

David Cowan 6.00am

Last Friday morning was a defining moment in David Cameron’s premiership and the history of the European Union.
The Prime Minister’s veto against modifications to the Lisbon Treaty without protection of Britain’s financial services has forced the seventeen Eurozone countries and up to nine of the remaining members of the EU to try to form a separate fiscal union. Mr Cameron has begun a process which could change fundamentally Britain’s relationship with Europe.
 
Will the German chancellor, Angela Merkel, and the French president, Nicolas Sarkozy, make a U-turn and grant the modest safeguards David Cameron wants for Britain’s financial services?
Or shall David Cameron have to face up to the challenge of resisting a Financial Transactions Tax (see Alex and Craig on the FTT, or Robin Hood Tax) and financial regulations, which will come through the back door by Qualified Majority Voting in the European Commission? As well as attempts by the Eurozone states to use the EU structure to implement their new fiscal union?
 
If Merkel and Sarkozy drop their opposition to David Cameron’s demands then last Friday’s events will be a footnote in history. A minor diplomatic victory of less value than John Major’s opt-outs from the single currency and the Social Chapter.
It would also lead to a fiasco similar to David Cameron’s ‘cast-iron guarantee’ to hold a referendum on the Lisbon Treaty, since there is no legal basis for a referendum on a new EU Treaty for fiscal union in the Eurozone. The lack of a referendum, while being legally apposite, will inevitably cause much discomfort in the Conservative party.
Last October’s parliamentary rebellion and polling by the Guardian/ICM has shown how Euroscepticism is a more mainstream view than it has ever been and the majority of the Conservative party now believes that it is time to repatriate powers from the EU.
 
However, there are those who do not see this moment of crisis as the right time to discuss EU reform given how Britain is suffering from a crushing national debt, sluggish growth, high inflation and rising unemployment. Indeed the TRG’s chairman, Tim Crockford, has stated that economic recovery is more important than EU reform.
It is true that half of the economic debate is about how we start to reduce the national debt, get inflation under control and make our economy more competitive but the other half is about how we respond to the changes being brought about by the Eurozone states during this crisis. Allowing more taxes and regulations to flow from Brussels will only exacerbate the first half and do nothing to address the second half of that debate. This is not an argument for ‘isolation’ but for greater ‘internationalism’ in trade, as Fraser Nelson has splendidly put it in the Spectator.
 
David Cameron and George Osborne cannot continue to allow EU red tape to hold back economic growth. The Working Time Directive, Agency Worker Directive, European Banking Authority and the Social Chapter are just some of examples of the EU bureaucracy which is suffocating British businesses.
Britain is already 83rd in a list of 142 countries for uncompetitive government regulation.
Tory Reform Group MPs have urged for a serious drive towards deregulation in the EU. The TaxPayers’ Alliance has highlighted an ambitious list of powers which can be repatriated.
This would be a reasonable course of action supported by the majority of the Conservative party and would boost economic growth but it would also be a test of whether or not a ‘multi speed Europe’ can work - though not very likely given how the modest demand for the protection of Britain’s financial services has been refused. A further refusal from the other EU states to allow the repatriation of powers could well act as the trigger for a referendum on British withdrawal from the EU.
 
For the moment we cannot say where events will take us. David Cameron delivers a statement to the House of Commons later today and this may well signal what the next step will be.
Yet however it plays out, this could very well be the beginning of the end of Britain’s membership of the European Union.
Follow David on Twitter @david_cowan

The misguided Tobin Tax is a threat to the City and should be resisted

Alexander Pannett 6.45am

This week has seen the return of calls for a Tobin tax to be imposed on financial transactions across Europe.

First, the German finance minister, Wolfgang Schäuble, called for the tax to be implemented in the Eurozone, even if countries such as the UK objected.

Next, the head of the Church of England, Archbishop Rowan Williams, ploughed into the debate by backing a so-called "Robin Hood" tax and suggesting it would stabilise currency markets, which would boost rather than damage the real economy and would not lead to sharp falls in employment.

Such naivety is hard to stomach when, as the Mayor of London, Boris Johnson, has pointed out, such a tax would clearly damage the City, which competes globally against rival financial centres who will benefit from the higher costs imposed on London.

The Tobin tax is a minor tax on all financial transactions that would, advocates argue, discourage speculation, promote the stability of financial markets, and raise revenue that could be used for the funding of real economic activity rather than on complicated financial products.  It is said that it would discourage short-term holding of securities and so effectively end the short-selling that has helped fuel the European sovereign debt crisis.

Such a view is particularly simple and ephemeral and ignores the fact that market liquidity will be severely hampered by such a restrictive tax.  This will lead to prohibitively higher costs for those who have the least access to liquidity, namely small and medium sized companies.  The consequential costs will hurt consumers, not the “too big to fail” financial institutions that the tax is intended to cull. Hedging would also be made much more difficult and therefore risk control in financial transactions will be made more expensive and less effective.

In short, the tax, instead of stabilising markets, will increase volatility as markets will find it harder to correct themselves.

The tax also has nothing to do with the causes of the credit crunch.  It was not the volume of financial transactions that caused the current recession, nor the fact that speculators shorted securities that they correctly believed were over-valued.  The mis-allocation of risk throughout the financial system was the main trigger of the current crisis.  This started with asset-backed securities which were triple-A rated but whose underlying assets were revealed to be worthless American sub-prime mortgages and moved on to cover European sovereign debt where near-insolvent governments’ debts had mistakenly been rated as having the same risk as those of largely debt-free governments.

The ability to hold short-term positions allowed the market to react quickly when it discovered that risk had been mis-calculated.  The market corrections that resulted publicly exposed the flaws in the economic models and structures that underpinned the financial system and forced vitally needed changes. 

Where speculation was deemed to be exacerbating downward pressures unnecessarily, temporary bans on short selling were imposed that calmed the markets and allowed governments time to re-capitalise financial institutions.  Once markets were deemed to have settled, these bans were lifted. 

A Tobin tax would not have prevented such extreme short selling as the temporary bans did and would have hampered market reactions to flawed economic models.  It would not have prevented the credit crunch nor would it have alleviated the consequences of the financial crisis. 

Worse, the tax would have a disastrous effect on London’s position as the world’s pre-eminent financial center.  The City competes in a global market and the tax would result in the cost of trading being higher than competitor financial centers in Asia, North America and the Middle East.  Investors and financial institutions would move their business away to cheaper jurisdictions, which is why the tax has not received any support outside Europe for it to be implemented by other major financial centres.

The higher costs would also be passed down to customers, raising the cost of mortgages and diminishing pensions.  This would lead to high unemployment and a reduction of European GDP of between 0.5 per cent and 1.8 per cent, as estimated by the European Commission itself, which is madness at a time of severe recession and would completely negate any revenue raised from the tax.

Reform of the financial services industry is needed and more must be done to re-balance the UK economy by encouraging specialised manufacturing, hi-tech start-ups and green energy.   However, clumsily undermining one of the most productive economic assets that the UK has for no real benefit to the European economy is unacceptable.  The Tobin tax is an interesting concept but unless it is adopted globally, it will achieve much more harm than good.

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For more on this subject, see Craig Barrett’s article from August: ‘The Robin Hood Tax is a soundbite tax worth ignoring’.

Ed Miliband’s “bad business” tax is a bad soundbite waiting to happen

Craig Barrett and Nik Darlington 9.55am

In a heavily trailed speech to be made in Liverpool later today, beleaguered Labour leader Ed Miliband will declare a tax war on “bad” businesses. He will blame the “asset strippers” who take more out than they put in, whilst lauding the individuals and businesses who put in “hard graft”.

The catch-all soundbite is about creating a “something for something culture” in Britain, rather than what Mr Miliband will refer to as a “fast buck” mentality.

Party conferences are hotbeds of unfunded, un-thought-through ‘policies’. A tax on “bad” businesses - a subjective call at best and political discrimination at worst - is such a ‘policy’ which, like the mooted tuition fee cap, is unlikely to make it to the Labour party manifesto in 2015 (Mr Miliband’s line, not ours). Like the Robin Hood Tax and the 50p top rate, it is a soundbite tax: designed to titillate, not to work.

The stupidity of this Manichaean idea is something to behold. How it would function is unfathomable. And it would drive highly mobile success (already taxpaying) companies offshore. This in the week that Twitter announced it would be setting up its European headquarters in Dublin rather than London for tax reasons.

This is what Craig wrote about the Robin Hood (or Tobin) Tax in August:

The compelling results of a study made by the Adam Smith Institute demonstrate that a tax on all trades from one currency into another simply wouldn’t work. For Britain, it could be disastrous. Some 20 per cent of the UK’s GDP is generated in the City of London, whose generated wealth is already subject to taxation. Foreign exchange trading in the UK accounts for 36.7 per cent of the world total. If we were to adopt a Tobin Tax, that proportion would surely fall - the revenue gained from further punishing the financial sector would come nowhere near to replacing the revenue lost as a result of the inevitable flight of financial institutions to other jurisdictions. And that’s because for a Tobin Tax to work, it has to be universal.

The only place where it has been tried seems to be Sweden, resulting in something of the order of 50 per cent of trading in Swedish equities switching to London. The tax raised only one-thirtieth of what allegedly wise men predicted. Unless all nations adopt it, those who are sensible enough to stay out of it will rapidly reap the benefit. Capital is mobile - real money no longer exists and institutions owe little loyalty to their domiciles. We can see this in the shift of UK companies abroad to take advantage of better tax treatment. As Ned Beatty’s character in Network (1976) nearly said - “there are no nations, only currencies”.*

The problem is that the Robin Hood Tax, or Tobin Tax (call it what you will), is a “soundbite” tax - something that those who wish to jump on the bank-bashing bandwagon can drip-feed to their supporters like a dealer teases with heroin. It is a tax for people who don’t or won’t understand economic reality and who want to curry favour with people who can’t be bothered to think past “soak the rich” or “the bankers caused the cuts”. Worst of all, and perhaps most unpalatable, it’ll be a tax on the UK to pay for the failed Euro-experiment which we were sensible enough to stay out of. Let’s put up a sign - “No Lupins today…or any day”.

At least the Tobin Tax, however flawed, has some basis in financial economics. A “bad business” tax has no basis in anything other than visceral ignorance.

Opposition is a lonely place in British politics. You struggle to make yourself heard at the best of times.

On the day you find yourself behind in the polls to a Government overseeing the worst economic climate in living memory, you really will say anything for a soundbite. For what it is worth, Ed, this isn’t a good one.

Follow Craig on Twitter @MrSteedUK

Robin Hood Tax is a “soundbite tax” worth ignoring

Craig Barrett 3.17pm

There’s a Monty Python sketch where John Cleese plays a highwayman called Dennis Moore (a name chosen presumably because it fits with the use of the old Robin Hood TV programme theme tune). In a typically eccentric twist, his demand is for “your money or your lupins” and he distributes the floral proceeds of his crime to a crestfallen Michael Palin. Lupins are, after all, pretty but useless.

A Tobin Tax seems to me to be much the same. It’s not even particularly pretty. It is referred to as a “Robin Hood tax” in the mistaken belief that it takes from the rich and gives to the poor, missing the point that Hood was simply returning the proceeds of over-taxation to the tax-payers rather than acting as some species of socialist redistributor.

The compelling results of a study made by the Adam Smith Institute demonstrate that a tax on all trades from one currency into another simply wouldn’t work. For Britain, it could be disastrous. Some 20 per cent of the UK’s GDP is generated in the City of London, whose generated wealth is already subject to taxation. Foreign exchange trading in the UK accounts for 36.7 per cent of the world total. If we were to adopt a Tobin Tax, that proportion would surely fall - the revenue gained from further punishing the financial sector would come nowhere near to replacing the revenue lost as a result of the inevitable flight of financial institutions to other jurisdictions. And that’s because for a Tobin Tax to work, it has to be universal.

The only place where it has been tried seems to be Sweden, resulting in something of the order of 50 per cent of trading in Swedish equities switching to London. The tax raised only one-thirtieth of what allegedly wise men predicted. Unless all nations adopt it, those who are sensible enough to stay out of it will rapidly reap the benefit. Capital is mobile - real money no longer exists and institutions owe little loyalty to their domiciles. We can see this in the shift of UK companies abroad to take advantage of better tax treatment. As Ned Beatty’s character in Network (1976) nearly said - “there are no nations, only currencies”.*

The problem is that the Robin Hood Tax, or Tobin Tax (call it what you will), is a “soundbite” tax - something that those who wish to jump on the bank-bashing bandwagon can drip-feed to their supporters like a dealer teases with heroin. It is a tax for people who don’t or won’t understand economic reality and who want to curry favour with people who can’t be bothered to think past “soak the rich” or “the bankers caused the cuts”. Worst of all, and perhaps most unpalatable, it’ll be a tax on the UK to pay for the failed Euro-experiment which we were sensible enough to stay out of. Let’s put up a sign - “No Lupins today…or any day”.

Follow Craig on Twitter @MrSteedUK

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*He actually said, for those who are interested in this absolute gem of a film:

Arthur Jensen: You have meddled with the primal forces of nature, Mr. Beale, and I won’t have it! Is that clear? You think you’ve merely stopped a business deal. That is not the case! The Arabs have taken billions of dollars out of this country, and now they must put it back! It is ebb and flow, tidal gravity! It is ecological balance! You are an old man who thinks in terms of nations and peoples. There are no nations. There are no peoples. There are no Russians. There are no Arabs. There are no third worlds. There is no West. There is only one holistic system of systems, one vast and immane, interwoven, interacting, multivariate, multinational dominion of dollars. Petro-dollars, electro-dollars, multi-dollars, reichmarks, rins, rubles, pounds, and shekels. It is the international system of currency which determines the totality of life on this planet. That is the natural order of things today. That is the atomic and subatomic and galactic structure of things today! And YOU have meddled with the primal forces of nature, and YOU… WILL… ATONE! Am I getting through to you, Mr. Beale? You get up on your little twenty-one inch screen and howl about America and democracy. There is no America. There is no democracy. There is only IBM, and ITT, and AT&T, and DuPont, Dow, Union Carbide, and Exxon. Those are the nations of the world today. What do you think the Russians talk about in their councils of state, Karl Marx? They get out their linear programming charts, statistical decision theories, minimax solutions, and compute the price-cost probabilities of their transactions and investments, just like we do. We no longer live in a world of nations and ideologies, Mr. Beale. The world is a college of corporations, inexorably determined by the immutable bylaws of business. The world is a business, Mr. Beale. It has been since man crawled out of the slime. And our children will live, Mr. Beale, to see that… perfect world… in which there’s no war or famine, oppression or brutality. One vast and ecumenical holding company, for whom all men will work to serve a common profit, in which all men will hold a share of stock. All necessities provided, all anxieties tranquilized, all boredom amused. And I have chosen you, Mr. Beale, to preach this evangel.

Howard Beale: Why me?

Arthur Jensen: Because you’re on television, dummy. Sixty million people watch you every night of the week, Monday through Friday.