Bank executives should face greater liability for losses

We released a report today, Market-based bank regulation: Creating incentives that promote responsible banking, which argues that a market-based alternative to orthodox bank regulation should be adopted to promote responsible decision-making behaviour by banks. The paper looks at the historical example of 19th Century American banks, where executives and shareholders faced liability for twice the value of their shareholdings. This double liability shareholding system led to lower failure rates and incentivised bank executives to limit excessive risk-taking. The author, Mikko Arevuo, argues that a variant of the system should be introduced today to discourage risky behaviour.

The report suggests two market-based solutions, both of which could make bank managers more responsible for losses. These are:

• Creating a special class of employee shares that become convertible to common shares at the prevailing market value after 5 years, at a rate of one employee share to one common share. Should the bank fail before the strike date, bank executives would be held responsible for the losses up to the value of their shares on the date they were received.
• Alternatively, attaching a restriction to executive bonus payments that make them subject to a ‘claw-back’ clause for a pre-defined period of time, up to 10 years.

For these proposals to be fair, they should be targeted only at those executives who have the power and authority to make decisions that have a material impact on the bank’s risk profile. As a result there would be greater managerial oversight over the risk-seeking activities of employees.

A move to these market –based solutions would re-align incentives to promote sound executive decision-making. This would be preferable to our current traditional capital adequacy based banking regulation, which has been unable to cope with the risk seeking behaviour of bankers and the moral hazard that is embedded in the modern banking system. The implicit promise of bailouts for failing banks holds taxpayers to ransom to cover losses incurred as a result of poor managerial decisions. Many of the current regulations have sought to restrict certain banking activities and set limits to executive compensation levels, which is unlikely to anticipate the causes of the next banking crisis.

Instead Market-based regulation would increase incentives for bankers to think seriously about the risk-return implications of their business decisions. This will be good for the financial services industry and would reduce the need for excessive micro-management and regulation of banking activities, while making executives at least partially liable for the costs that bank failures and losses impose on society.

Mikko Arevuo, author of the report, adds: “Public anger at the behaviour of banks and bank executives is fully understandable.  Taxpayers and voters, quite rightly, demand that something is done about irresponsible risk-taking and poor managerial judgment by executives.  However, the political default position of more regulation is a blunt instrument.  It will result in higher costs that banks will eventually try to pass on to their customers.  Moreover, an overly complex regulatory framework may result in the creation of risks that no one had predicted in advance, as banks try to find ways around the new regulations.   Finally, regulation is often a poor tool in changing human behaviour.  My paper was written to provoke debate about the role of regulation in changing managerial behavior. I believe that effective regulation should focus on incentivizing managers to behave in the interest of their firms’ key stakeholders, rather than focus on the institution level capital adequacy-based frameworks."

The report was covered in the Daily Telegraph and Money Marketing today.
 

Putting the small shopkeeper out of business

One of the more important things that is happening in the world economy at present is that India is finally getting to grips with rent seeking in that economy. They have decided that foreign supermarkets may enter the market in a big way for the first time. This is, predictably, causing consternation among the small shopkeepers who rightly suspect that they will be put out of business:

A strike has been called by the opposition Bharatiya Janata Party, as well as communist parties, which will see schools, public transport and many independent businesses shut down for the day. Thousands of kirana, owners of small independent supermarkets, also plan to close their shops to protest against the government's decision to allow foreign stores to enter the market. Many large international chains already have shops in the country, but are only allowed to sell to smaller shopkeepers, not directly to consumers. The ruling Congress party's controversial plan would allow them to compete for market share with existing retailers in an attempt to attract further foreign investment and boost the economy.

It may or may not boost the economy: but it will certainly boost the efficiency of the economy. For two reasons.

The first is that, as we've noted before, some 50% of all food grown in countries like India is wasted. It rots somewhere between harvest and the plate or is contaminated by pests, that sort of thing. Having an efficient logistics chain will thus reduce the amount of food being wasted. Something rather important in a country like India that has so much malnutrition. And yes, at least one recent report on how to feed the world has indeed said that exactly what places like India need is that very efficient logistics chain. That chain which the supermarkets provide.

The second though is a little more complex. Those small independents, plus many of the stallholders below them in the retail hierarchy, are going to get put out of business by the more effcicient supermarkets. This is of course a problem for them and their jobs. But from the viewpoint of the economy and the consumer such jobs are a cost, not a benefit. If it is possible to distribute food with 5 million instead of 10 million people then that is an advance: as a whole the economy would then get the food distributed plus whatever the production is of those 5 million displaced labourers.

Such transitions are not easy on those displaced and I am not cackling with glee at their likely suffering. Yet why are they protesting? Because they know that the previous ban on the competition provided them with rents in that Indian economy. The sweeping away of the prohibitions is going to detroy their ability to demand those rents from the consumers. Do not forget, by the way, that if the consumers actually prefer the small supermarkets then the large ones will go bust as they will get no custom. So what is really being asked of the Indian people as a whole is, well, what do you prefer? Lower prices and efficiency or that lovely social feeling of the locally owned and much smaller retail outlet?

This may only be happening in one country. But India's population is indeed large, well over one billion people. That one seventh of the entire species will soon be gaining access to cleaner and fresher and cheaper food is indeed an important world event, no?

The change is one toward more liberty as well: all to the good. Now, if only we could get our own rulers to put quite so much political effort into abolishing rent seeking.....

Thank heavens for speculation in commodities futures!

Isn't it just absolutely marvellous that we've got all those bright people and all that vast amount of lolly tied up in speculation in futures on agricultural commodities?

The mass slaughter of millions of farm animals across the world is expected to push food prices to their highest ever levels.

Well, not quite.

Nicholas Higgins, a Rabobank commodities analyst and author of the report, said: "There will be an initial glut in meat availability as people slaughter their animals to reduce their feed bills. But by next year herds will be so reduced that there won't be enough animals to meet expected demand and prices will soar."

That's it: the price of meat is likely to rise next year: after the fall caused by people slaughtering the animals they won't be able to feed next year. And this is why we're so lucky we've got all those people selflessly providing price signals to us.

This year's harvest looks like being pretty miserable. At least for nothern hemisphere corn and wheat they do. As a result of this those speculators, doing good in their gilded towers, have bid up the price of corn and wheat for delivery later this year and next. There will be less of it around they think. This is what is known as a "price signal". Those people who might feed cheap corn to a bacon buttie on the hoof, cheap wheat to the vital ingredient of a future Big Mac, won't feed them the expensive stuff. So, less bacon (sob, sob) and less Mickey D's (honestly, who cares?) and as a by product there's more corn and wheat around to feed to people. Because we're using less of our now limited supply to feed animals.

All of this is achieved by (mostly) men playing around in offices with money. Not that they intend these results of course: they're driven purely by the greed, the lust, for filthy lucre. Yet as a result fewer people will starve than would in their absence.

And to think that there are people out there who would stop speculation in food. Presumably they're too stupid to see what we get from the system. The alternative, that they would prefer people die for ideological reasons, is just too 20th century to consider these days.

A solution to the exams dilemma

James Croft, author of our superb report on profit-making free schools, is now head honcho of the Centre for Market Reform of Education, and has today released a paper that raises serious questions about the government's plans to replace GCSEs. The recommendations are refreshingly innovative, harnessing the innovative properties of the market to try to solve some of the problems that the government's plans are aimed at addressing:

Michael Gove is one of those reforming politicians who galvanises support by polarising opinion. In the media frenzy surrounding the announcement of the government’s reforms to Key Stage 4 (KS4) qualifications yesterday, it is unsurprising that there wasn’t much place for intelligent comment offering qualified support to his proposals. While recognising the concerns that the Minister seeks to address, there are good reasons why even those who share his concerns about the utility of GCSEs, and what should be done with the curriculum to address them, should feel some unease about his proposals. Fortunately, there is a market-based solution that fits squarely within the Coalition parameters, which would be feasible if the Conservatives were to be more conservative and the Liberal Democrats more liberal. […]

You can read the rest of this blog post on The Centre for Market Reform of Education website.

When Qualifications Fail: Reforming 14-19 Assessment, the Centre’s first discussion paper, by James Croft and Anton Howes, is published today.

A little bit of inflation is still too much

Headline inflation in the UK has fallen to 2.5% (from a peak of 5.2% a year ago), so there is great rejoicing. The monetary hawks (such as Liam Halligan) have been proved wrong, we are told – all the Quantitative Easing didn't actually fuel inflation. Meanwhile, the Governor of the Bank of England, Mervyn King, is relieved that he doesn't have to keep writing to the Chancellor, as the law requires when the inflation target is widely missed.

But is everything so hunky-dory in reality? At the most basic level, there are some price-raising pressures in the pipeline. Oil keeps going up, the utility companies are raising their prices, and poor harvests around the world this year cannot help. But as every good monetarist knows, rises in some prices, however important, cannot raise prices overall. If there is a fixed amount of cash around, people can only spend more on one sector (like food and energy) if they cut back on others (luxury goods, say, or housing).

And the fact that prices are rising only moderately suggests that all the Bank's quantitative easing is not actually having much effect on the real economy. It certainly seems to be keeping up asset prices, which is why the stock market is looking so healthy. But maybe it is not seeping into the everyday economy. Maybe it just replaced the collapse in the money supply when the banks found themselves caught in the headlights and stopped giving out loans any more. Still, the monetary hawks would say that as and when the economy recovers, the Bank of England needs to be able to rein things in again or all this new money really will have an effect on prices – and reining people in is a lot harder than engineering a boom.

But as the deepest level, I still wonder why we should regard inflation of 2.5%, or the Bank's central inflation target of 2%, should be remotely acceptable. At that rate, the value of our money halves in 30 years. Which is great if you are a big creditor, like the government, because you are repaying your debts in devalued money. And indeed the government is charging us tax on the interest we get on our savings, even though these are negative in real terms. And as incomes struggle to keep pace with the inflation, more of us find ourselves drawn into the higher-rate income-tax brackets. And so on. It all favours the spendthrifts and punishes the savers.

Keynes figured that inflation is useful because of the downward inflexibility of wages. People don't like pay cuts, but pay in declining industries can be cut in real terms simply if it does not rise as much as prices. So people are gradually eased into more productive jobs without any nastiness. Keynes, though, did not realise just how damaging inflation is to signals in the economy. When all prices are rising, it is hard to separate the 'noise' of generally rising prices from the 'signal' of prices that rise because demand is not being met. For years, people invested in houses because they saw house prices going up and up, without realising that, after inflation, the rise was much less. So you get bubbles in some places, and underinvestment in others. None of which helps competitiveness and employment.

There is also an argument that a bit of inflation is fine because of the seignorage in the system. Put simply, as people get wealthier they keep more cash to hand, in their pockets, wallets and current accounts, without worrying about it so much. So you can have more money in circulation without it driving up prices, because there is more money lying dormant round the place. Maybe. But I still don't see why that is a reason to create so much money that prices, driven by the non-dormant bulk of the cash, rise beyond zero.

There is also an argument that it is wise to allow a bit of inflation because if by mistake we tipped into deflation things would be really terrible. With falling prices, why should anyone buy today what they could buy cheaper tomorrow? So business would grind to a halt, we're told. But in fact, inflation is equally destructive – killing the incentives for saving and investment, encouraging false booms, diverting resources into the wrong places. Should it not be a key duty of the government to preserve the value of our money – not to let it lose its value at 2.5% or indeed on any scale at all?

No more truckin'

The Department for Transport has announced plans to implement a new charge of up to £10 a day on foreign lorry operators using British roads, a move it is claimed will increase UK competitiveness, boost growth and create a ‘level playing field’ for British lorry drivers. Hurrah! No more Johnny Foreigners coming over here congesting our roads and stealing British jobs!

But I think I may have noticed a flaw: how does making it more expensive for overseas businesses to trade here increase UK competitiveness and boost growth? The last I checked, protectionist policies don’t work. It is not only the foreign lorry companies that will suffer, but the businesses that use them to transport their goods to the UK, who will just move their trade elsewhere. At the very least, the bulk of the losses will be transferred on to the imported products and services. As a result, competitiveness between UK and foreign businesses and haulage companies will decrease and the price of goods and lorry services will rise.

Geoff Dunning of the Road Haulage Association has celebrated the move, which he says ‘will lessen the financial advantage currently enjoyed by our European neighbours.’ Reducing the competition both for haulier companies and the goods brought over by them will probably help the UK haulage industry by reducing transport options for businesses and allowing them to charge more for their services, but it certainly won’t do anything good for the rest of us. The ‘advantage’ referred to is that foreign lorry companies can operate cheaply here, while UK companies have to pay road charges and tolls when abroad. However, making it more expensive for foreign drivers to operate here does not make it cheaper for domestic drivers to operate abroad. Indeed, it risks sparking reactionary policies discriminately charging British lorry companies working overseas.

Of course, we always have that nice little figure of £20m in expected tax revenues to look forward to each year from the move. Except for the fact that foreign lorry companies will move their services out of the country due to the combination of the new charge and the vehicle excise duty, which is much higher than its equivalent in most EU countries. Even if we were to raise something close to that amount, it is unlikely to be spent efficiently on things such as road maintenance.

Instead of this, why not significantly reduce the vehicle excise duty and allow private investors the freedom to build more tolled roads, similar to many systems in continental Europe? This would boost economic growth, maintain UK competitiveness, keep prices down and improve road conditions. This is not a new idea, but one that is failing to attract serious attention from policymakers. It is certainly better than driving away foreign business and increasing prices because British hauliers aren’t efficient enough to compete.

Making the case for open borders

I've got a post on the New Statesman's website today, beating the drum for open borders. I open with the story of Srinivasa Ramanujan, an Indian mathematician born into abject poverty a century ago:

Born to a poor family in southern India in the late nineteenth century, Ramanujan displayed a remarkable mathematical mind from an early age, developing complex theorems as a teenager.

He was a genius, but he left school in poverty and seemed destined to live a life of subsistence. By chance, Ramanujan was discovered by another Indian mathematician and ended up at Cambridge, producing ingenious new ideas and eventually becoming the first Indian to be elected a Fellow of Trinity College.

Ramanujan was lucky. Had he not been discovered when he was, he could have easily spent a life in poverty, his genius untapped and giving nothing to the world.

The west’s immigration laws make it remarkably difficult for latter-day Ramanujans to exploit their potential. Ramanujan represents not just the geniuses lying fallow in subsistence agriculture, but all human talent that is not being tapped to its full potential.

Whether the reasons are poor governance, cultural constraints, poverty or other restraints on human productivity, billions of people are being condemned to lives of relative squalor, with no way out.

Read the whole thing.

All cats go to heaven

YouTube is an incredibly easy way for ordinary people to communicate with one another and the world. It is therefore open to abuse, the consequence being that much of its content is not to be taken seriously: extraterrestrial Freemasons, Leonid Brezhnev rap videos, and amateur films mocking religion and religious figures -- any religion you can think of, from Scientology to the Church of Raptor Jesus -- abound. Yet last week Google took the unprecedented step of banning one single YouTube video in three countries (Egypt, Libya and India) in order to protect the sensibilities of the peoples who populate those lands.

Amid all of the stupidity one can find on YouTube, it is difficult to understand why this is necessary. In individual life, one would only expend such an effort on behalf of a truly delicate little snowflake, someone for whom the facts are simply unbearable. One does not tell one's three-year-old that the cat, Fluffy, has died; Fluffy goes "to Cat Heaven". One does not, in a group, call out a compulsive liar mid-flow; one "smiles and nods" and pretends to be amused, and then slowly backs away. One does these things of one's own free will, to protect an interlocutor from shock or humiliation, and for the sake of convenience, because causing a scene would result in the expenditure of far more effort than it is worth.

To try this trick with nations of men is another matter, and one with civil liberties implications. Steve Henn, writing for National Public Radio, points out that in the present context, Google's censorship is "an example of the challenges of balancing U.S. free speech concerns and of something known as the 'heckler's veto'" -- the problem faced when one person or a group of people resort to extreme means (e.g. threats of violence) in order to silence public discourse. This has happened several times in the past several years (think Terry Jones and Jyllands-Posten). And on each occasion, the riots failed utterly in their aims: as even the most cursory search on Google will reveal (find it yourself - I will not provide a hyperlink for reasons which will become readily apparent in the following paragraph), the liberal peoples of the West have responded to extremist tantrums by producing mountains of blasphemy and ridicule, the most recent iteration being the film implicated in last week's unrest.

But before we congratulate ourselves for our tolerance and humanity, we should take a hard look in the mirror. Last week, in Leeds, on 14 September (3 days after the attacks which destroyed the U.S. consulate in Benghazi), Azhar Ahmed, a 19-year-old from West Yorkshire, was convicted of making "derogatory, disrespectful and inflammatory" remarks under the Malicious Communications Act. His crime? Writing a Facebook post which stated, shortly after the funeral of a number of British soldiers from the area, that "all soldiers should go to hell". In the United Kingdom, such a communication falls foul of a provision of the Act which states that "a person who sends to another person a(n)... electronic communication... of any description which conveys a message which is indecent or grossly offensive... is guilty of an offence if his purpose [or one of them] in sending it is that it should... cause distress or anxiety to the recipient". He made the post; distress was intended and caused; judicial sanction followed.

At this point I would say, being a lawyer, that he made the crucial mistake of putting it in writing. But if he'd yelled the same thing at a funeral (or even a parade), that would have been of no assistance to the free exercise of his rights: a case on nearly identical material facts, but relating to spoken expression (R v Abdul, 2008) resulted in a half-dozen convictions under Section 5 of the Public Order Act. And this is far from the only case of its kind - there are dozens of reported cases showing that all manner of political speech, religious speech, and even the casual F-word can, under the right circumstances, fall foul of the legislation. The man on the Clapham omnibus has as much of a heckler's veto as the Salafist on a Cairo street; furthermore, the man on the Clapham omnibus is state-backed.

David Cameron described the attacks on the Libyan embassy as "senseless". I totally agree. In a free society the expression of a controversial opinion by an individual should not, under any circumstances, justify the threat or application of violence by other men in order to silence that opinion.

But Azhar Ahmed has been so silenced. Until we end the criminalisation of those opinions which offend us, we cannot justifiably claim that we are any different from the mob.

Why we want to break up the NHS

The National Health Service is, or at least was, a near monopoly. Monopolies are a bad thing and therefore we want to break up the monopoly.

However, there's long been a school of thought that says that monopolies, while they might not be positively good things, aren't actually all that bad. It might be acceptable to have the teensie, tiny, costs of monopoly if there is some over-arching reason to do so. Like, for example, the much vaunted "fairness" of equally bad access to healthcare for all. This argument rests on the costs of monopoly being teensie. They ain't:

This paper reports on a new literature that takes a different approach to the costs of monopoly. It examines the costs of monopoly and tariffs within industries. In particular, it examines the histories of industries in which a monopoly is destroyed (or tariffs greatly reduced) and the industry transitions quickly from monopoly to competition. If there are costs of monopoly and high tariffs within industries, it should be possible to see those costs whittled away as the monopoly is destroyed. In contrast to the prevailing consensus, this new research has identified significant costs of monopoly. Monopoly (and high tariffs) is shown to significantly lower productivity within establishments. It also leads to missallocation within industries: Resources are transferred from high- to low-productivity establishments.

Thus we want to break up the monopoly. Indeed, we've seen evidence of rising productivity as a result of the limited competition already extant. Two data points: NHS England had limited competition between establishments while NHS Scotland and Wales did not. Productivity (ie, amount of treatment, number of treatments and quality of treatments for the same money) rose in NHS England in a way that they did not in Wales or Scotland. Secondly, we found that when limited competition (on quality not price grounds) was introduced in NHS England that those areas with more competition increased productivity (same measure, more and better treatment for same cost) more than those areas with less.

New theory tells us that monopoly is worse for productivity than we had thought. If this were so then relaxing the monopoly should result in an increase in productivity. We have so relaxed and we are seeing increases in productivity. Thus we desire to relax the monopoly.

None of this stops the tax financing of at least some health care of course. It is only an argument about the mechanism by which the actual service is delivered: not by a monopoly please.

This is just too delicious for words

So, they've finally nailed one of the bankers, fined him and banned him from The City.

Peter Cummings, the HBOS banker whose division lent billions of pounds to property developers, has been given a lifetime ban by the Financial Services Authority for his role in the banking crisis. Cummings, who has also been fined £500,000, is the only former HBOS banker to be penalised by the City regulator as a result of the near-collapse of the bank which was rescued by Lloyds in September 2008 - and the highest profile banker to be punished since the financial crisis.

I find this all just too delicious for words.

Let's just potter through the standard critique of The City and banking shall we?

Everyone was too committed to trading and products rather than relationships. Too much investment banking and not enough commercial banking. Exotic products and derivatives rather than proper loans to real businesses. Even, not enough real investment, only loans.

We're told that the answer to all of these problems is to divorce investment from commercial banking. To tax, with the Robin Hood Tax, that socially useless trading. To reduce the productisation of things and to go back to relationship banking. To encourage banks to provide real capital, equity, not just debt and loans.

I'm not being unfair here, am I? This is generally the current received wisdom, yes?

So, which banker do we actually fine and ban from The City? The one who used no derivatives. Did not do any trading. Was a straight commercial banker, nothing to do with the socially useless stuff at all. Who invested in real companies making real product. Who was willing to invest equity as well as just provide debt finance. Whose activities would not have been affected for one moment by a Robin Hood Tax.

One of these three things has to be wrong. The initial analysis of the basic problem, the solution to that perceived problem or the bloke we've dumped the blame upon.

Unless, that is, we English are even better at irony than our global reputation already suggests. Punishing the guy who did what everyone says all bankers should now just do is irony, isn't it?