Reviews for "City of Thieves"

"An insider's view to insider trading ... written with vigour and authority."


"...a brilliantly constructed, intelligent, thrilling read."


"A thriller that puts the boot into bullies in the City's financial world."


Monday, 14 February 2011

The government's approach to banker bonuses is flawed

Government subsidies, if they are to be effective, need to be targeted. In the case of the banks, taxpayer funds that were intended to rebuild the banking system’s capital base, to enable them to lend more and to absorb future lending losses, are instead simply being paid out in bonuses.

Caught up in the blame game of trying to shift responsibility for the banking crisis, government ministers are returning to their old tricks. Today’s generation of politicians seem to think that taxation is the answer to all our woes. Many of those who pass our tax laws have never worked in the private sector – let alone run a private business – and are oblivious to the economic damage that high taxes can inflict upon industry. Since income taxes were first introduced by William Pitt the Younger in 1798 as an easy means of funding government expenditure, successive British governments have become accustomed to responding to new problems simply by introducing new taxes. Westminster’s answer to global warming? Green taxes. A bloated, inefficient public sector? Yet more taxes. Excessive banker bonuses? Excessive banker taxes.

Whilst governments are right to attempt to contain excessive banker remuneration – especially when it is directly or indirectly funded by the public purse – higher tax rates rarely achieve their intended purpose. Rather, they tend to have a negative connotation. They discourage enterprise and investment. They encourage a highly mobile industry to relocate overseas. All these things work ultimately to reduce the overall level of tax revenues flowing into the Treasury’s coffers.

Instead of playing a tune that appeases voters, politicians are more likely to achieve lasting results if they start talking the language of business. If the banking industry expects taxpayers to be their insurer of the last resort, then the government should extract a premium for that service. That insurance premium should be sufficiently large on a collective basis to cover the cost of the last bail out as well as paying for the next one.

Banks should be left free to decide whether or not they need these government-backed insurance contracts. But those banks that choose not to insure their balance sheets would naturally be deemed high risk by the markets – by shareholders, creditors, customers – and by regulators. They would see borrowing costs rise relative to their peers. Bank shareholders and bond holders would all be put on notice that, in the event that their bank runs into capital or liquidity problems that warrant government intervention, their investments might be wiped out. Under these circumstances, the likelihood is that all bank executives would see the commercial imperative of insuring their operations against default.

As is normal practice in the insurance industry, the government – as sole insurer – would perform a rolling risk assessment of the industry, segmenting the banking industry into high risk, medium risk and low risk players, each carrying an appropriate premium. Some parts of the banking system may carry such high risks as to be uninsurable. If so, those parts of a bank would have to be segregated and would be ineligible for taxpayer funding. Indeed, as a country, we may well be better off if the riskiest parts of the banking sector left the country. They would then become a problem for another set of taxpayers.

The insurance premium would naturally reduce the pot available for bonuses. Unlike taxation, an insurance scheme provides a strong market-based rationale for capping bonuses. To tackle the bonus culture, further measures are required. We need to return to the basic principles of any good employee incentive scheme. Bonuses should be tied to the performance of the individual and the company. If the company performs disastrously, employees must share the pain. Banking profits should be calculated on a more prudent basis, with greater general provisions for future losses, so as to smoothen profits out over time – after all, many banking executives announced record profits in 2006, only to hit their shareholders with record losses a couple of years later. Bonuses should only be paid out of profits, not losses. Short term bonuses should be replaced with long term bonuses. Tie an employee’s bonus to his pension scheme and I guarantee you he will think twice about taking big bets.

If such rules were made clear now, bank executives would be forced to put their house in order, to manage costs better, rather than casually assuming that they will be bailed out with impunity. Investors would have greater clarity over which banks would be saved and which would be allowed to fail. Aggrieved shareholders or bond holders would have no case for claiming compensation.

Some argue that the Basel III rules already provide an implicit form of insurance against bank failure. The Basel III Committee in Switzerland agreed last year to raise the minimum core Tier 1 capital ratio from 2% to 7% by 2019. The problem with the Basel III rules is that they are essentially internal controls which can be easily manipulated to give regulators the perception that they are being followed. Whilst Basel III provides banks with an internal buffer against future losses, it would help to have an external buffer before the tax payer is called upon to rescue the sector.

Remember that a lack of capital and a lack of liquidity were the two primary causes of this crisis. Had banks put aside enough capital and enough cash to cover their losses, we may not be in this mess today. But banks are never likely to maintain adequate capital over the long term because their industry suffers from ‘moral hazard’ – that is, bankers know that if their own capital reserves are inadequate to absorb future losses, they can always rely on the taxpayer to bail them out. If banks are forced to pay a premium for the taxpayer guarantee their industry demands, the problem of moral hazard partly falls away. In the long run, that is the only way to prevent the banking industry from bringing us all down.

Thursday, 23 December 2010

Net neutrality

America has introduced new rules which are likely to change the Internet forever. Many bloggers argue that, as a result, the Internet will become less open and free. The Obama administration has publicly supported this view of an open and free Internet, but privately leaned on the Federal Communications Commission - America's telecom regulator - to push through new 'net neutrality' rules which do the opposite.


Regulation, by its very nature, distorts markets in the name of a ‘higher purpose’. Back in the early 1990s, when the Internet was first commercialised, America’s telecom regulator  introduced a policy of 'network neutrality', which meant that telecom networks were not allowed to discriminate against any type of Internet traffic for any reason. The policy was designed to encourage innovation on the Internet. It worked. America is now home to seven of the world’s top ten Internet companies. But it came at a price. Investment in America’s broadband networks suffered, because net neutrality policies effectively capped the price of Internet bandwidth forcing operators to charge sub-commercial rates, thereby reducing their financial incentive to invest in tomorrow’s high speed broadband infrastructure.

Today, the ‘higher purpose’ that drives US regulatory policy has changed. America has finally woken up to the fact that the country that invented the Internet has slipped to 14th place in the world league table of broadband speeds – average broadband speeds in Japan and Korea are ten times faster than in America. The government’s new policy objective is to encourage investment in high speed broadband infrastructure. To achieve that objective, the Obama administration had two options: it could provide federal subsidies or it could allow market forces to do the job. The first option was not feasible because the government is running an unsustainable federal budget deficit, so the second option – which involved relaxing net neutrality rules – was the only viable solution.

On Tuesday 21 December 2010, the FCC voted to pass new laws on net neutrality. These new laws represent the start of the biggest U-turn in global Internet regulation that we will see in our lifetimes. The big change announced by the FCC was that US broadband network operators like Verizon and Comcast will now be allowed (for the first time ever) to charge Internet companies like Apple or Google for preferential access to their pipes. This paves the way for additional revenue streams that were not legally permitted before yesterday. The context of this move is that America, like Europe, has an Internet bandwidth bottleneck, causing it to slip down the world league table of broadband speeds. So the political motive for this regulatory U-turn is to incentivize the broadband providers to build next generation high speed broadband networks before America’s competitive advantage in the information age is damaged. In mobile networks, where the bandwidth shortage is more acute, certain types of Apps may even be legally blocked in order to ‘manage traffic’ better.

Net neutrality rules are important because they determine who controls the Internet – the telecom operators or the Internet companies. The new rules announced this week by the FCC tip the balance of power in favour of the telecom operators. Internet companies like Apple, Google and Netflix may now have to pay millions of dollars in additional charges to ensure their Internet content is delivered reliably and quickly to their customers.

Other countries will soon follow America’s lead, especially in Europe, where they are close to making their final decision on net neutrality.

The Internet is no longer free and open. Simply a victim of its own success.

Wednesday, 10 November 2010

Gold Wars

In the last ten years, the price of gold has quadrupled from around $300 per troy ounce to around $1,400. Western investors now see gold in the way that middle class Indian families have always seen it – as a reliable store of wealth.

The rise of the gold price reflects the decline of the US dollar as the world’s reserve currency. After the World War II when the USA was the world’s largest net exporter, the US dollar strengthened on the back a strong US economy that exported to the world. Since the US was not only the strongest economy, but also the largest, its currency became the world reserve currency. That meant trade was conducted in dollar terms and commodities like oil were priced in dollars. The USA’s manufacturing base gradually went into decline as factories moved to cheaper locations like China, but the dollar remained the world reserve currency. That meant that the US could spend above its means and simply print money to make up the balance. But without the underlying economic strength to back up its currency, the US risks losing reserve currency status.

This week, Robert Zoellick, President of the World Bank, suggested that gold may once again be viewed as an alternative to currencies. The world once had a gold standard, but abandoned it in 1945, replacing it with the Bretton Woods system of fixed but adjustable exchange rates. That system broke down in 1971. Since then most industrialised nations have let their currencies float freely. Over the last decade, the big exception to that rule has been China. Despite being the world’s second largest economy, its largest net exporter and its largest energy user, China still effectively fixes its exchange rate.

Since 1971, floating exchange rates provided an excellent release valve for trade imbalances; when a country exported more than it imported, investor confidence in its currency would push up its exchange rate, making its exports more expensive, thereby reducing its trade imbalance. But that system has come unstuck. The world’s largest economy, the USA, is printing money – it has just embarked on a second round of quantitative easing to the tune of $600bn. Simultaneously the world’s second largest economy, China, is artificially keeping its exchange rate down. As trade imbalances inevitably worsen in these conditions, investors will gradually move away from the US dollar towards either a basket of reserve currencies (e.g. the dollar, renminbi, yen and Euro) or towards a gold standard.

In theory, a gold standard requires some element of your currency to be backed up by gold bullion. The Chinese have been building up huge reserves of gold bullion with their foreign exchange reserves. The US too has large supplies, but nowhere near enough to support its currency. The UK sold much of its gold reserves for a quarter of today’s price under Gordon Brown’s chancellorship between 1999 and 2002.

Under a gold standard China would become stronger and America weaker. Net importers like France and the UK would also become weaker. The price of your currency is a symbol of power. The world will fight over gold. That fight will get dirty.

And that dirt is the setting for my second novel.

Wednesday, 29 September 2010

Wall Street, the sequel

After 23 years, the sequel to Wall Street has finally been released. Its producers do little to curb rumours that it is based more on fact than fiction. It's opening line "The first thing you need to know about Churchill Schwartz is that it's everywhere" is a clear reference to the 2009 Rolling Stone article on Goldman Sachs.

The script shows that even Gordon Gekko, who embodied the 'Greed is Good' era of the eighties can change ... after a few years in prison ... and adopt an alternative view to capitalism. But one man cannot change the system.

Or can he?

Read my novel, 'City of Thieves' to get an alternative view of Wall Street.

Monday, 19 April 2010

Another banking crisis looms

The public’s anger towards bankers stems from their refusal to exercise any form of humility (i.e. pay restraint) in the wake of the biggest banking rescue package in history. Politicians’ anger is based on bankers’ resistance towards the reform measures needed to avert another banking crisis.

Some economists say that the cost of this financial crisis has already exceeded 6% of world GDP – or over $3trillion. Britain has borne the brunt of this – relative to the size of its economy – because it relies so heavily on financial services. The British government's budget deficit has risen from 2.4% of GDP to 11.8% of GDP in just two years, purely as a result of the recession that followed the banking crisis. And it could all happen again. Only next time, it could bankrupt the country. That’s what makes banking reform the biggest election issue of all. It is being ignored at our peril. If banks are not reformed, we may all be the proud donors of another multi-billion bank bailout within the next parliament.

So let’s re-examine what went wrong in banking and ask how we should fix it.

What went wrong?
Before we look at the causes, it’s worth reminding ourselves what banks actually do. Banks don’t sell cars or iPods or hamburgers. Banks sell trust. You go to the bank, you hand over your money and you TRUST that they will give it back to you when you need it. And of course when an industry is based on trust – solely on trust – there is an awful lot of scope for abuse.

And over the last 10 to 20 years, bankers have blatantly abused that trust. Simply by not putting aside enough money – enough ‘capital’ – to guarantee that they could pay back the money they owed when things got tricky.

Now trust takes a long time to acquire. London became a leading banking centre because it had built up trust over the centuries. Then somewhere along the way, the honour dropped out of the banker’s dictionary. Traditional, safe banks became hijacked by pirates, by treasure hunters, by risk takers. People who rarely risked their own money, but were happy to risk yours. And to add insult to injury, they’d get you to pick up the losses whilst they kept the bulk of the profits.

How did this come about? And why did so many commentators brand this an Anglo Saxon crisis? Well, the two single biggest triggers were Anglo Saxon:

1. Big Bang, 1986, UK

2. Repeal of Glass Steagall, 1999, USA

Big bang in 1986
Big bang was the sudden deregulation of the UK’s financial markets under Margaret Thatcher. It was done to make London an attractive place for foreign banks to set up shop. And it worked. It became easier to get a banking licence and you could do more with it. Everyone, especially the American banks, came to London to do what they weren’t allowed to do by law in their own back yard: take excessive risks and invent highly complex products that no one could understand.

London became one big free-for-all and banking became ridiculously complicated overnight. No one could understand how everything fitted together any more, or how some of these fancy derivatives worked, least of all the boards of the banks that took big risks with our money.

Repeal of glass Steagall act in 1999
The Glass Steagall Act was the 1933 political response to the credit crisis that created the Great Depression in the 1930s. Its sole purpose was to prevent bankers from putting savers’ deposits into risky investments. It separated retail banking from investment banking. The risky bit of banking would stay in investment banks and the safe bit in retail banks.

There was a good reason for this split. Depositors regard banks as an institution whose core role is to safeguard their money. Attaching a casino to a bank is not the best way to safeguard depositors’ money. And that’s exactly what the Glass Steagall Act was designed to do – to prevent bankers for making bets with your money.

President Clinton repealed the Act in 1999. That allowed the investment banks to take your money and gamble it away, laying the foundations for this crash.

So within two decades you had a banking regulatory environment that was just asking for trouble on both sides of the Atlantic. In the UK, you had regulation that was so light it was virtually invisible. In the US, you had the government openly signalling to their banks that it was OK for them to use depositors money to invest in risky assets like subprime debt.

As if that weren’t enough, you also had cheap money, thanks to Alan Greenspan, the Chairman of the Federal Reserve. That meant banks could borrow money at very low interest rates. Cheap money can be a good thing if it is used to lend to solid, growing businesses to generate wealth and jobs. But when cheap money is simply used to make the bankers themselves rich, that’s what Lord Turner was referring to when he described them as socially useless. And that’s what they did. The banks used cheap money to gear up their own positions to absurd levels. For example, Lehman Brothers balance sheet, just before it went bust, had a gearing ratio of 40x. That meant that for every £1 of its own money it invested, it borrowed £39 from someone else. In the old days, that ratio was closer to one or two.

Did you spot the problem? If you did, you’ve passed the test to become CEO of an investment bank. Congratulations. We know from our own experience that too much borrowing can bring us down. Yet, the banking regulators ignored this danger. They simply left the banks to manage their own risk and to police themselves and then looked shocked when they turned the place into a City of Thieves.

Now it’s easy to bash regulators. But it’s not so easy to be one. Banking regulation is a difficult balancing act because your number one priority is to ensure banks don’t go under. Yet banks by the nature of what they do are always technically bankrupt: to be bankrupt means you are unable to pay short term debts as they fall due.

Banks borrow short term and lend long term. At any point in time they are always technically bankrupt, because they are unable to pay all their depositors at once, because of the maturity profile of their assets. The only thing that actually stops banks from going bankrupt every day is confidence in the banking system. And the job of the regulator is to maintain confidence in the system. So the Bank of England, when it was in charge, had sensible rules that had been developed over hundreds of years to safeguard depositors’ assets – to make sure that our money was rarely put at risk:

Basic common sense rules and guidelines:

- Don’t lend over 3x borrower’s income (for housebuyers)

- Keep sufficient general reserves to allow you to cope with bad times

- Pay bonuses only out of profits not out of revenues

- Golden rule: don’t invest in anything you don’t understand

In 2007, not one of these basic common sense rules was being followed at any major bank. Why? Partly greed, partly the global nature of banking flows and partly bad regulation.

Regulators simply do not understand all the new banking products that have been emerging with alarming speed – it’s not because the products were particularly complicated or that regulators are particularly stupid – although both are undoubtedly true – it is because banking itself had become too complex for any one human brain to comprehend.

Of course, the biggest problem the regulator faces is exerting authority over the bankers themselves. Let me put it this way, how do you give orders to someone who is taking home a hundred times what you make? It kind of saps your confidence a bit, don’t you think?

Causes of the banking crisis
Today, as we exit this banking crisis, we do so knowing that another crisis is inevitable. How do we know this? Because the three main causes of this crisis have not yet been addressed.

1. Bonus culture

2. Moral Hazard

3. Conflicts of interest

Bonus culture
When I was young, looking in from the outside, the City looked like the perfect world – clever people using their brains to make lots of money. As a Cambridge undergraduate I was once seduced by this dream. But when I became an insider, I very quickly learned the truth. Investment bankers weren’t succeeding because they were smart; they were making money because they were bending the rules and fixing the match, the authorities stood on the side line and turned a blind eye as vast tax receipts rolled in. The City is not a place for the principled.

In the boom years, bankers justified record bonuses by pointing to record profits. And herein lies the problem. You see, the problem with banking is that you never know what profit you’ve actually made until years – sometimes decades – later. It’s always a guess. After all, many bank executives reported record profits to their shareholders in 2005 and 2006 only to hit them with the biggest banking losses in banking history just a year later in 2008.

Banks are not like any other company. If you read Ford’s accounts, things are pretty simple. They bought this much steel, this much plastic, put it together with a bit of electronics and wheeled out this many cars. Make a few adjustments and hey presto, this is your profit – or loss in their case. The key thing is, in the majority of industries, most of that profit is actually generated by selling your product and banking the cash. Profits will, of course, be manipulated by accounting adjustments and be affected by year end stock levels. But the maximum stock a car company, say, might hold could be a month’s worth of cars, maybe two months.

At a bank the maximum stock – by way of loans – could be twenty years. But whilst a bank’s profitability can only be certain in the long term, bonuses are paid out in the short term. If things turn sour from one year to the next and you’ve paid out too much in bonuses – tough shit.

Banks can manipulate profits like my baby daughter can manipulate her daddy. Banks calculate a big element of their profits not by what they’ve sold, but by pricing what they haven’t sold. In the jargon, it’s called mark to market. These profits are sent up or down at the click of a computer mouse. They’re not based on real sales – like they are at Ford, or Apple or McDonalds. They’re based on guessing the value of their assets. The higher the valuation of those assets, the higher the bonus pool for the banks’ key executives. By the time we figure out what the real value of a bank’s assets are – the bonuses have already bolted out the door. And all your left holding in your hand is the same stuff that I’ve got every morning right after my daughter’s nappy change. And it stinks.

The banking industry’s line on bonuses is, of course, predictable: Talent has to be rewarded. Risk takers have to be rewarded. Recent bonuses have been close to all time highs, yet what risk have bankers taken when their businesses have been underwritten by taxpayers? George Soros, the legendary investor, summed this up in an interview he gave the FT recently, “Those earnings [referring to bankers’ bonuses] are not the achievement of risk-takers. These are gifts, hidden gifts, from the government.”

As I said earlier, banks sell trust. When you’re in the trust business, you have to act honourably. And honour simply doesn't sit comfortably with bonuses. Greed and honour just don’t go together. They’re like chalk and cheese.

So to those people who say that we need to reward talent with multi-million dollar bonuses, I say you’re hiring exactly the wrong kind of talent. Honour doesn't come with such a heavy price tag.

Moral hazard
Some would say that if you live by the sword die, you should die by the sword. The sword of bankers is capitalism. The first rule of capitalism is that you should protect capital; yet all banks failed to do that. The second rule of capitalism is that it is survival of the fittest; yet bankers expect taxpayers to bail them out when they lead their businesses to the brink of bankruptcy. The third rule of capitalism is that the providers of capital should reap the biggest rewards. Yet the biggest provider of capital to UK banks over the last two years has been the UK government – on behalf of the UK taxpayer. We have provided direct capital injections into banks like RBS and HBOS and indirect capital support to banks like HSBC and Barclays, who would have lower profits had taxpayer’s money not come to their assistance. Yet, as the largest provider of capital, the UK government seems to have little control over how its own capital is allocated. No doubt that is partly because the capital was handed over to the banks at a time of crisis, when the Treasury was more concerned about averting financial meltdown than negotiating a good deal for the taxpayer. Yet now, after averting the banks from bankruptcy, the banks seem to be in a state of ‘employee capture’. Bank employees are grabbing capital provided by their shareholders to enrich themselves rather than using it to recapitalise their banks. That’s not supposed to be how capitalism works.

And that’s because capitalism in the banking sector has been distorted by moral hazard - the concept that bankers will continue to take excessive risks with other people's money as long as they know that the government will be there to bail them out.

The concept of moral hazard is against the instinct of all free market economists. In capitalism, if you take big risks and fail, you go bankrupt. That’s the end of it. In the banking sector however, several banks took large risks, secure in the knowledge that they were too big to fail.

Now I’m not going to argue why we need to save big banks – that’s obvious – the economy would collapse if the banking system collapsed. What I want to focus on is why have banks taken on such big risks. And that leads me to the conflicts of interest that continue to plague the banking sector.

Conflicts of interest
Now there are many types of conflicts of interest within a large investment bank. My book, City of Thieves, for example, covers one type of conflict – the conflicts an analyst faces every day. He’s under pressure to change a rating because somebody somewhere in the bank stands to make a lot of money by manipulating stock ratings. That type of conflict is well documented. It was headline news in 2002, when Eliot Spitzer, the New York Attorney General humiliated the top 10 US investment banks by pointing out that analysts like Merrill Lynch’s Henry Blodget were telling clients to buy internet stocks whilst internally saying they were crap.

Spitzer fined the banks $1.4bn for allowing these conflicts to go unchecked. A year later he was very publicly discredited when he found himself embroiled in a prostitution racket. Since then very few regulators have had the guts to take on the banks with quite the same vigour and success as Spitzer. So the banks just returned to business as usual. Back to precisely the same bad old tricks, for which they had been fined $1.4bn back in 2003 by Wall Street’s highest ranking law enforcement officer.

As a result of the conflicts exposed by Spitzer, pension funds and other big investors still – to this day – do not trust the stock research flowing out from the big banks. There’s always an angle, always a hidden agenda behind it. An analyst at a big bank is supposed to provide independent analysis. But he has a lot of big hitters to please back at head office – the commercial lending guys, the M&A guys, the equity capital markets team, the derivatives team and the fixed income guys. And it shows in the research.

Going one step higher than conflicts faced by stock analysts, the mother of all conflicts of interest is how banks handle your money. Remember, bank’s sell trust. You give them you’re money and trust you can get it back any time. You might even pay them a fee to hold it. You expect them to take care of it, to put it in safe investments. But of course safe investments don’t generate big returns. Risky investments generate big returns... sometimes.

So the biggest conflict of all in a bank is that bankers are tempted to put money – your money – that should be destined for safe investments into risky investments, without telling you about it. It’s a major conflict because it goes to the very heart of what banks are – custodians of our money.

As a society, our livelihoods and even our happiness are to a large extent determined by the morals and values that we are taught to hold dear. They are ingrained in us from an early age and they form the fibre of our being. We never really think about them until they are undermined.

So if any of you out there want to find your dream job working for a big investment bank, then remember what’s important. Banking is about honour. My generation forgot that. Make sure you don’t.

Saturday, 13 February 2010

The Pensions Time-bomb

If you’re worried about saving for your pension, I’ve got news for you. Your own pension isn’t the one you should be worrying about. You’re likely to pay more into other people’s pensions than your own – those other people being the millions of public servants with gold-plated pensions that you and I will be funding for the rest of our lives.

And just to add insult to injury, remember that, by law, paying for public sector pensions takes priority over saving for your own pension. After all, paying taxes is mandatory whilst making private pension contributions is voluntary.

In pensions, like in many other areas, most public sector employees have faced little, if any, pain, while the rest of the country has just recovered from cardiac arrest. Until the public sector feels the recession the rest of the country has been experiencing for the last two years, their excesses will sink us all.

The Deputy Prime Minister, Harriet Harman, has built a career on fighting inequality. In fact, she’s about to introduce even more legislation to deal with it. Yet her forthcoming Equality Bill seems to have missed one of the biggest inequalities of all – the inequality between public and private sector pensions.

In the fifties and sixties the British government, like many other governments around the world, struck a deal with businesses in the private sector – let’s call it the pensions contract. If businesses looked after their workers in their old age, the government would offer them generous tax deductions for their efforts. A key element of that deal was longitude; for it to work, it had to be a long term deal. After all, most of us spend 40 years saving for our pension. If the pension deal changes halfway through our lives, how can we possibly plan for our retirement?

When Gordon Brown became Chancellor, he systematically set about breaking that 40 year promise through a series of stealth taxes. But he did not raid everyone’s pension – only those less likely to vote for him. As he chipped away at private pension pots, he gold-plated public sector ones, including his own, that of the civil service that report to him and other public sector servants that he likes to champion. The result is that the country has accumulated a pension liability it cannot afford, and – worse than that – the benefits are grossly skewed to favour public sector workers, rather than the private sector workers who pay for it. Here are two examples of Brown’s stealth taxes on private pensions:

In 1997, Brown abolished Advanced Corporation Tax (ACT) relief on private pension funds. Terry Arthur, a fellow of the Institute of Actuaries, has estimated that this policy alone has reduced the pension funds of private sector workers by between £100 billion and £150 billion. Brown kept public sector pensions gold-plated.

In 2008, following the credit crunch, Darling removed a host of tax benefits from private sector pensioners, but – again – left public sector pensions gold-plated.

These double standards serve not only to create inequality between private and public workers in retirement, but also to shorten the fuse wire of the public pension time bomb that could one day bankrupt our country.

Here are some of the policy areas the government needs to rebalance if it is serious about tackling the problem.

Disclosure imbalance
Private companies are obliged by law to calculate and disclose their pension liabilities on their balance sheet. The government exempts itself from this rule. We know what governments pay out in pensions each year, but not how much they will have to pay in future, based on commitments they have given. The government should disclose its best estimate of our public sector pensions liability on its balance sheet, just as it asks private sector businesses to do.

Funding imbalance
Private companies are obliged by law to fund their pensions fully. If there is a pension deficit, the pensions regulator has the powers to force companies to devise a plan to fund that deficit within ten years. This kind of policy can be very costly for business. For example, BT this week announced announced a £9bn pension deficit – that’s about the size of the BT's entire market value. BT has a 17 year plan to plug the deficit, but City analysts are worried that the pensions regulator might force BT to act faster. That caused its share price to collapse on 11 February 2010 by 12%. Ironically that, in turn, caused pensioners in other private sector companies to lose out too, as most UK pension funds hold BT shares. Despite such heavy handedness when it comes to the funding of private sector pensions, the government does not fund its own pension fund. Instead, today’s pensioners are paid by today’s taxpayers. This should change. The government should put aside a proportion of tax revenues to fund its own public sector pension liability, in the same way that it asks the private sector to do.

Risk imbalance
The more the government raids private sector pensions, the more private sector companies renege on their side of the pensions contract. Many private businesses have closed their defined benefit schemes (which guarantee pensions on the basis of a worker’s final salary) and switched to defined contribution schemes (which pay into a fund which may or may not grow to provide an adequate pension, depending on market conditions). This switch from defined benefit schemes to defined contribution schemes takes all the risk away from business and places it on labour - workers have no certainty with regard to either the final pension amount of their pensions or whether they will get one at all. By contrast, public sector workers get a guaranteed pension – they carry no risk, because the risk is carried by us taxpayers. Governments should pass responsibility for public sector pensions to public sector workers, in the same way that they have forced private companies to do.

Security imbalance
Public sector pensions are guaranteed. Private sector pensions are a lottery. You can save all your life and still end up with nothing. Much of this has been due to poor government regulation of the private sector fund management industry and a failure of the government to provide private pensioners the same safety net they offer public sector pensioners.

In 2000, Equitable Life, a private pension provider, effectively went bust. Those people who depended on the company for their pensions were told to make do with substantially less than they expected, with some getting nothing until they signed away their rights. In July 2008, the pensions ombudsman, Ann Abraham, published a highly critical report on the government’s handling of Equitable Life and called on the Prime Minister to set up a compensation scheme for policyholders who lost money. Her rationale was that the government’s poor regulatory oversight had largely contributed to these pensioners losing most of their life savings. The government refused to comply, despite being found guilty of what many would describe as gross negligence.

The government should protect private sector pensions (by stronger regulation) with the same vigour that they protect public sector pensions. After all, the main reason private sector pensions are under-funded is because the government has repeatedly raided those funds.

Efficiency imbalance
When private sector businesses face falling revenues, they cut costs to survive, and often their workers have to pay. When the public sector faces falling tax revenues, they seem to follow a different set of rules. All too often, they are quick to take on debt and slow to control spending, landing taxpayers with a higher bill for tomorrow. Like businesses and households up and down the country, governments need to live within their means. That means that they must fire inefficient workers and cut unnecessary expenditure. Failure to properly manage budgets must carry consequences for ministers.

Enough is enough
There comes a point when a nation can no longer afford its commitments. At that point, governments have to take action before it is too late. Large economies like the US – whose currency is the world’s reserve currency - can borrow large sums from foreign creditors. For smaller countries like the UK, there is a limit to the amount of government borrowing the market will bear. As Chancellor, Gordon Brown insisted that it was not prudent for a country to borrow more than 40% of GDP. Yet, by 2012, Brown now expects UK net government borrowing to reach 78% of GDP. He’s broken his own self-imposed golden rule – and that’s before accounting for the nation’s public sector pension liability.

What makes the problem more acute is that there is little incentive for politicians of any persuasion to fix it. The problem has a 50 year time line, but most politicians don’t plan much beyond 5 years to the next general election. Nobody in Westminster is taking the long term view on pensions.

Fixing the pensions problem will hurt more people than it will benefit. So it’s a medicine that no politician wants to offer the electorate: public sector workers will have to work longer and accept lower pensions; politicians will have to fire incompetent civil servants, doctors, policemen and teachers; public services will have to be prioritised with the lowest priority services cut. In a country, where more than 60% of British families receive some kind of government handout, you are destined to lose an election by suggesting that those handouts are no longer affordable.

Last week Greece had to beg France and Germany to save it from bankruptcy. It had a strong card to play – it was part of the Euro zone. If Greece collapsed, the Euro would be badly damaged as a currency. Britain is not in the Euro zone. If we collapse, no one in Europe will help us. Only the IMF stands between us and the edge of a cliff. And when the IMF lends, it doesn't mess around. The country will get a sudden jolt, with a massive drop in living standards until we have brought our debts under control. We tried that medicine in 1976 and it wasn’t pleasant.

The government is set to bring in an Equality Bill. Let it sort out the lack of equality in our pensions before this time-bomb blows up in all our faces.

Wednesday, 20 January 2010

The Cadbury Sellout

Rarely does a big corporate takeover create value for those who should be entitled to it. Instead, company executives and bankers tend to hoard the profits from the deal for themselves, whilst shareholders, customers, taxpayers and workers get sold out by the very people they looked upon to protect their interests. Something is wrong with capitalism when a badly run American plastic cheese company can take over a well-run British jewel in the crown for a ridiculously cheap price and get away with it.

Today a whole line of Cadbury’s stakeholders were betrayed by their own board, who allowed Kraft to acquire Cadbury for a paltry £11.6bn. The bankers to both parties in this acquisition will probably walk away with close to £300m in advisory and financing fees whilst the boards of both companies will probably award themselves lucrative bonuses – Cadbury’s CEO alone is in line for a £20m payout from this one transaction. The only other winners in this deal are the short term hedge fund managers who bet on the fact that Cadbury’s was a takeover target – these are the same group of people that Lord Turner, Chairman of the Financial Services Authority, recently described as socially useless.

Meanwhile there a string of losers:

Kraft shareholders are likely to lose because the true cost of this deal is far higher than their CEO Irene Rosenfeld is letting on. Leave aside the fact that this deal only makes sense if Rosenfeld can achieve significant cost savings and synergies – something most mergers singularly fail to do, according to many management gurus. Then there are the borrowing costs, which are misleadingly low – Kraft will have to borrow $12.7bn dollars more to finance this acquisition. That’s easy when interest rates are 0.5% - the lowest they’ve ever been in peacetime history. But when the economy picks up and interest rates start rising, Kraft shareholders will have to pay higher rates to rollover their debt. That will make them big losers, but by that time Rosenfeld might have jumped ship with a nice pay off

Cadbury’s shareholders are likely to lose because their board allowed the company to be sold during a recession, when the company was valued on the cheap. The Cadbury board were happy with Kraft’s offer of 850p per Cadbury share. Yet there is a case for arguing that Cadbury’s shares are worth 1200p or more, if one takes account of its longer term growth prospects.

Cadbury’s customers will almost certainly lose out. In this world of globalisation, profits are everything and quality doesn't even get a seat on the board. A company that makes cheese for McDonalds hamburgers will be tempted to cut the expensive ingredients that give Cadbury’s customers the wholesome taste they crave, with something that is cheaper and less healthy.

Cadbury’s 45,000 strong global workforce is likely to be decimated as Kraft seeks cost savings and its UK workforce is likely to take the biggest hit as head office jobs move to the USA. If Kraft faces difficulties in future, you can bet that overseas territories like the UK will see job losses before the US workforce feels any pain.

The UK taxpayer is likely to lose substantial tax revenues now that Cadbury’s global profits will flow through the USA taxman rather than the UK’s. Given that Cadbury’s allegiance to the UK economy is now all but historic, there will be an adverse knock on effect on future manufacturing jobs and investment in the UK too.

All too often British politicians seem to be petrified of engaging in any kind of industrial policy, even if it appears to be in our national interests. The British version of capitalism seems to be rewarding the wrong sets of people (short term profiteers) and penalising the good guys (long term investors, British consumers and British taxpayers).

Yet the UK government seems to be the only major government that stands by and allows this to happen. After all, in 2006 the Americans prevented Dubai World from becoming the owner of their ports when it purchased P&O, the British company that owned them. In 2005, the French passed a law that protected ‘strategic industries’ from foreign takeover. Ironically, the law was dubbed the ‘Danone Law’ because it was hastily drafted to protect Danone, a niche French food producer, from a possible takeover bid by Kraft or Nestle. Imagine what would happen if a foreign predator – possibly state-controlled by a hostile or undemocratic state – wanted to buy BT? Would we want our telecoms network – one of the most strategic assets any nation has – to be owned by an outsider? Military commanders are persistently warning politicians that cyber warfare is a major threat to our defence. Yet under current legislation, the British government no longer has its golden share in our main telecoms network company BT, so it could conceivably be sold to any number of sovereign funds or overseas players.

So what can be done to stop the national treasures of UK plc being sold to foreign predators on the cheap, thereby protecting our national interests in the long term? Here are some suggestions:

Formulate an industrial policy that protects our strategic industries. Designate certain industries as ‘strategic’. Pass legislation that allows the UK government to veto any takeover of a company in such a strategic industry on grounds national interest. Such industries should include defence, telecoms, energy and manufacturing. As the French did with their ‘Danone Law’, so we should use Cadbury’s as the trigger to launch a national industrial policy.

Change the balance of power in big corporations to favour long term investors. Companies are notionally owned by shareholders, yet too often boards go against the interests of long term shareholders, as they did in Cadbury’s case today. Change the law so that shareholders who have held a company’s shares for 10 years (i.e. your pension fund) have a far greater say in takeover decisions than shareholders who want to make a quick buck over 10 days (your average hedge fund).

Change the composition of the board to include worker representation. In Germany, unions sit on the board, giving the workforce a say in decisions that impact their livelihoods.

Bar board executives from profiting from takeovers. Make it illegal for company CEOs to get a pay off when their company is sold off. How can a CEO properly protect his shareholders if he gets a payoff the minute he surrenders. More importantly, how can it be right for Cadbury’s CEO to walk away with £20m for doing a deal that so badly damages the Cadbury workforce, Cadbury customers, the UK economy, and UK taxpayers?

Change the tax system to favour long term investment. Allow investors who have held shares in a UK company for over 5 years to take profits tax free, but charge the full capital gains tax rate (currently 18%) for any profits made by short term investors (i.e. those who bought and sold within 5 years). If you want to be kind to hedge funds, you can have a sliding scale that is most punitive for those short term investors who jump in and out of shares on a daily or weekly basis.

Change the tax system to neutralise the advantage of debt versus equity. Currently there are tax advantages for companies who wish to raise money from the debt markets over those who raise it from the equity markets, because interest on debt is tax deductible whilst shareholder dividends are taxable. By giving debt and equity equal tax status, CEOs like Rosenfeld would think twice before piling up debts for Kraft shareholders.

Put an end to the era of cheap money. With interest rates at 0.5%, credit is too cheap. Companies can borrow at virtually no cost, making it very easy for badly run large corporations to take over well-run smaller corporations. Logically, you will end up with a catastrophically run mega corporation. Who benefits from such takeovers except a clique of insiders – bankers, boardroom bosses and hedge fund managers?

Whilst some of these suggestions are common sense, parts of the financial services sector will lobby hard against them. Don’t let them hold us to ransom. When I realised what was wrong with the global investment banking sector, I left the world of corporate banking and wrote a book about it. Whilst “City of Thieves” is fiction, the issues it raises – issues such as greed, integrity and ethics – are very real. And the Cadbury’s debacle today has borne many of them out.

We don’t have to see UK plc be sold on the cheap. But it will take a tremendous amount of political guts to stop it, because we have to stand up to one of the most powerful industries in the world. And our politicians need to wake up to the challenge before it’s too late.