UK loss on RBS sale: so what

Bygones are bygones. Or as economists call them, 'sunk costs'. If you invest in something that doesn't pay off, you can kiss your sunk costs goodbye. Just sell for what you can get. Today we are being told that UK taxpayers are going to take a £7bn loss when the government sells its stake in the the mega-bank RBS. Add fees and costs, and it might be £14bn. So what?

When the UK's Labour Chancellor Alastair Darling spent £45bn of our money bailing out RBS – and another £63bn on Lloyd's, Bradford & Bingley, Northern Rock and the rest – he wasn't going through the Financial Times with a highlighter to pick good investments to enrich taxpayers. He was trying to rescue Britain's financial services sector during the financial crash.

For a sector that brings in £66bn a year in taxation, that was a pretty good deal. Yes, you can argue that if he had done nothing, the market would have sorted it out. Or that the government should have simply lent the banks more money. But at the time it was all pretty hair-raising. Banks exist on trust, because if all their customers pull out at the same time the banks don't (usually) have enough cash on hand to repay their deposits. They have lent out that cash to help grow businesses, jobs and prosperity. So when 20,000 queued up to take their savings out of Northern Rock, and the RBS said its cash machines were going to run out of cash in 48 hours, it wasn't unreasonable to do something.

Actually, when you look at that £108bn went, taxpayers are already in pocket. Slices of Lloyd's have already been sold off, and Northern Rock is looking like a really good business again. It depends on your predictions of what the remaining bits are worth, but taxpayers could already be £14bn up on the deal. That's no surprise: the same happened in Sweden when its banking sector was bailed out years ago.

So what of RBS? Bygones are bygones. The bank grew bloated in the boom years, and has had to spend hundreds of millions restructuring. And being involved in just about sort of financial business known to humanity, it has picked up more regulatory penalties than most. So it is trading well below the 502p share price that Alastair Darling bought it at.

But that money was spent, not on buying a bank as an investment, but on buying a bank to save it from utter collapse. Money spent, job done. Bygones are bygones, let's move on.

Should we wait until things improve, so that taxpayers get all their money back? No. After all, as they keep telling us, shares can go down as well as up.

The FCA meddles with investment banks

In June 2014, the Chancellor created a Fair and Effective Markets Review (FEMR) of financial services, co-chaired by the Bank of England, FCA and HM Treasury. The report is due next month but has been widely trailed. Before we see that review, and in an effort to keep itself busy, the FCA has announced a further review covering some of the same ground, the Investment and Corporate Banking Market Study (ICBMS): “We are examining issues around choice of banks and advisers for clients, transparency of the services provided by banks, and bundling and cross-subsidisation of services.” Each of these reviews takes a year and costs you and me hundreds of millions of pounds. The FCA spends around £480m, growing at 6% p.a., and this is their biggest single project. It must cost the industry a similar amount in dealing with the FCA’s 3,000 staff. We consumers pick up the costs: every bill from my stockbroker has a £20 “Compliance charge.” That is hardly a key issue for most electors as they vote on the government every five years, so this unrestrained incubus feeds itself.

This second review is not just duplication: neither should be necessary at all. Both arise from Treasury and FCA failure to understand how markets do and should work – and we now have the Competition and Markets Authority. It was launched only last year and could perfectly well cover financial as well as other services. I would even go so far as to allege that the financial services regulators’ adversarial approach is in part responsible for the scandals. The FSA, and now the FCA, have forced banks to close ranks to deal with what must seem to them a common enemy. As Adam Smith pointed out two and a half centuries ago, putting competitors in the same room is likely to be bad for competition.

The Bank of England, by contrast, used to preside over the sector in the manner of a kindly uncle, nudging potential miscreants away from their misdoing, but not taking on the sector as a whole. Maybe the BoE can recover that role.

The terms of reference of the ICBMS seem to indicate that the FCA suspects clients do not choose their banks and advisers in the way they should, that things are not fully transparent and that cross-subsidy of services is a malpractice.

The first of these is a remarkable suggestion: that the FCA knows how clients should make decisions better than the clients do. Enough said.

On the second, in any market, the products should indeed be fully and accurately described, as the law requires. In the case of manufactured foods, for instance, the labeling requirements are extensive. But the FCA’s brand of “transparency” implies more than just product description: it means revealing everything about the product. If it were applied to oranges, it would require not just the variety, country of origin and the terms of trade proposed, but also the name of the supplier, the date purchased and the price paid by the retailer. Markets do not work this way: competition, along with proper product description, protect buyers by enabling them to compare.

The third implication, that bundling and cross-subsidies are wrong, is the most revealing. When I buy a car, I do not expect to buy all the parts and then have to put them together. I could do that, but bundling the components is far more convenient, and cost efficient, for both parties. And if I make £1 on a dozen oranges but £2 on a dozen pineapples, are my pineapples cross-subsidising the oranges? But then if the oranges sell for 50p each and the pineapples for £2, my margin on oranges is 17% and on pineapples is only 8%. Now the oranges are cross-subsidising the pineapples. Which is the more wicked?

The reality is that every market allows the seller a maximum price whittled down by competition, every seller has different costs, and some things are therefore more profitable than others. The notion of “cross-subsidies” is fantasy.

The FCA’s meddling with financial services adds cost to the sector as a whole, in addition to the growing burden of EU regulation.  And it damages competition through a failure to understand how markets work.  And its antagonistic approach may even be creating a climate where malpractice is more likely.  In short, it is counter-productive.

Ring fencing banks

Apparently “City leaders” are now “in secret talks with Treasury on weakening the ‘ring-fence’ scheme after fears global lenders will abandon Britain” (Sunday Times, 17^th May).  This has been precipitated by the threatened departure from these shores of HSBC.  The only surprising thing about this news is that it has taken so long. My blog on the topic in December 2012 concluded “It is truly astonishing that this [Vickers] Commission should choose to focus its entire attention on the area that matters least [ring-fencing the banks’ retail activities].  The consequence of adopting their suggestions, as Vickers himself seems to be pointing out, can only be that we will hobble our own financial sector at great cost to the economy and the British taxpayer.”

The Treasury has to this day claimed that the public were demanding ring-fencing but that is nonsense.  Hardly anyone understands what it involves.  Invite the general public to sign a ring-fencing petition and see how many sign up.  The only reason they might is because the big banks do not like it.  Those few denizens of the City and Westminster who do understand what it involves fall into two camps: fantasists and realists.

The fantasists believe that investment bankers brought down their retail siblings and that, in turn, created the 2008 crash.  Actually it was caused by the retail sector giving mortgages, largely under US government instruction, to poor people who could not pay their debts.  Much the same happened in the UK: remember those building societies which turned themselves into retail banks?  They went to the wall first.

The realists know that however the regulators write the rules, those working for the same global corporation will find ways of cooperating.  That is what global corporations do.  Chinese walls are not even paper thin.

One, rather more practical, option was completely to separate retail from wholesale as the US used to do. That was abandoned by the Vickers Commission for good reasons.

The new government has better things to do with its time and attention than fiddle around with this, starting with resolving a deal with the EU.  There is zero chance that the rest of the EU is going to ring-fence their banks.  The Treasury should announce that, to be consistent with other EU banks, the whole topic will be postponed until after the EU referendum.

What's happened to the 'Bitcoin Revolution?'

Last Tuesday PayPal announced partnerships with the three biggest Bitcoin payment processors, BitPay, Coinbase and GoCoin. Merchants can now accept Bitcoin through PayPal’s Payment Hub platform, although the company hasn’t integrated the currency into its system directly. With over 143m registered users and $125bn worth of transactions last year this is a boon for the digital currency-cum-payments processor, which currently sees up to 80,000 transactions a day.

It's also a suggestion that the 'Bitcoin revolution' (if it is to happen at all) could be less explosive, more incremental, and far more reliant on existing processes than many might believe.

In many ways the last 12 months have been incredible for Bitcoin. It’s gone from an underground obsession to a mainstream curiosity and the darling of the FinTech world. Huge companies such as Overstock and IBM now accept payment in it, and the currency is on track to attract more VC funding in 2014 than the Internet did in 1995.

Yet for some Bitcoin's performance has been a disappointment. Despite all the investment and media attention, Neither Bitcoin’s price nor its use have seen anything like the exponential rise anticipated by its biggest proponents.

Enthusiasts are prone to making eye-watering predictions of Bitcoin's value, yet its price has been falling in recent months and is down from a peak of $1,000+ in December to around $400 in recent days. Bitcoin transaction volume has also stagnated around 100,000btc/day, a decline from around 250,000 last November & December.

There’s also been little vindication for the more ideological Bitcoin supporters, who view the protocol as a tool with which to challenge power structures and state legitimacy. Wall Street and the banking sector are more interested in harnessing the power of cryptocurrency and distributed ledgers for themselves than in lobbying to protect themselves from the technology. There’s also little indication that central banks (even privately) consider cryptocurrencies a threat to fiat currency. And whilst Bitcoin fans are quick to proclaim its resistance to state censorship, places like China and Russia have done a good job of suppressing its use within their borders.

Yet none of this renders Bitcoin a failure. Whilst crazy price rises no longer dominate the news and public interest may have waned, the past year has seen significant professionalization within the Bitcoin community and the development of a staggering amount of infrastructure.

Actors like the Bitcoin Foundation have worked hard to safeguard the Bitcoin protocol and to provide the currency with a ‘legitimate’ face. Bitcoin conferences now cater to serious investors and carry hefty pricetags to match. Self-styled crypto-consultants and established law forms vie to provide specialized advice, whilst groups like Google Ventures and Barclays Accelerator have their eyes on crypto-entrepreneurs. Whilst basic problems like securing an UK bank account for Bitcoin businesses persist, financial innovation in areas like Bitcoin derivatives which compensate for the currency’s volatility race ahead.

Lawmakers are also starting to take Bitcoin seriously. The UK Treasury has already offered really very reasonable tax guidance on Bitcoin and has a detailed report on it due out this Autumn. The Bank of England’s most recent Quarterly Bulletin labeled Bitcoin a ‘significant innovation’ and remarked that its underlying protocol has the potential to ‘transform’ the financial system as a whole.

This doesn’t guarantee that governments will make the right decisions or regulatory steps. Indeed, proposed legislation like NYC’s 'BitLicenses' threaten to affect Bitcoin companies across the globe. However, in the UK and the USA at least policymakers are seem interested in understanding Bitcoin technology and how it can contribute to society, rather than in controlling the network completely.

This ‘professionalization’ of Bitcoin invokes the ire of some members of the coin community, who regard it as selling out and the establishment of a new, powerful Bitcoin elite. Certainly, companies which pre-emptively comply anti-money laundering and know-your-customer laws applied to other financial services cannot utilize the full potential of Bitcoin technology. However, it is inevitably these boring, corporatized activities-  not transactions fueled by price speculation or clickbait about the Dark Web- that create the chance of a sustainable future for Bitcoin.

It also looks like Bitcoin’s success will be increasingly related to its integration with established payment, merchant and finance companies such as PayPal, Amazon, Apple and Visa. Bitcoin is a disruptive technology with the capacity to bring about huge changes, even within the confines of today’s regulated industries. However, these changes look likely to come with the help and blessing of today’s commercial giants, rather than by a process of immediate disintermediation.

For instance, Bitcoin is much more than the new PayPal, for it’s simultaneously both a currency and a payment processor. Despite this, Bitcoin’s price rallied significantly after a long period  of decline following the PayPal announcement. Whilst the Bitcoin protocol has absolutely no need for an Apple Pay or a debit card to transmit it (in fact Bitcoin was developed to render such third parties obsolete), there’s no denying that it would also work wonders for user adoption. As the Bitcoin ecosystem grows and seeks increasing legitimacy, integration with established companies is a very realistic route to long-term success. In addition these companies have much to gain from embracing Bitcoin early, rather than risk competing with it later.

Understandably, this doesn’t make the ‘Bitcoin revolution’ seem much like a revolution. But for libertarians and free marketeers there’s still much to celebrate. The fact that Bitcoin can reduce payment transactions fees by a couple of percent isn’t all that sexy, but the fact that it could slash the fees associated with remittances to developing countries certainly is. And if established companies like Western Union or M-Pesa can work with a Bitcoin company to speed up this process, so much the better.

There are also innumerable areas (many of which are still in their infancy) where Bitcoin and blockchain technology can work to make the world richer and freer, such as in providing finance for the unbanked , establishing a decentralized internet, or enabling Decentralized, Autonomous Corporations.

Bitcoin is still an alternative to fiat currency, which is great for those anticipating global monetary collapse as well as those experiencing extreme inflation in countries like Argentina. Bitcoin can still be used to circumvent capital controls, give funds to politically outlawed organizations, and to achieve increased levels of financial privacy.

As Bitcoin ‘legitimizes’ and enters the mainstream it is inevitable that the companies and services interacting with it will become regulated. There's even demand for the legislation, since businesses tend to prefer regulatory clarification rather than to be stalled by uncertainty. However, the beauty of the blockchain is that whilst companies and specific actions can be restrained by law, the underlying Bitcoin protocol cannot be controlled or regulated. This allows for disobedience and experimentation in the shadows. No matter how Bitcoin is taxed, treated or regulated in the open economy, the possibility of a parallel realm where no interaction with the current political and financial system is required- however small- remains as an enduring idea.

A bankers’ ethics oath risks being seen as empty posturing

The suggestion put forward yesterday by ResPublica think-tank that we can restore consumer trust and confidence in the financial system, or prevent the next crisis by requiring bankers to swear an oath seems excessively naïve. Such a pledge trivializes the ethical issues that banks and their employees face in the real world.  It gives a false sense of confidence that implies that an expression of a few lines of moral platitudes will equip bankers to resist the temptations of short-term gain and rent-seeking behavior that are present in the financial services industry.

In fairness to ResPublica’s report on “Virtuous Baking” the bankers’ oath is just one of many otherwise quite reasonable proposals to address the moral decay that seems to be prevalent in some sections of the banking industry.

I don’t for a moment suggest that banking, or any other business for that matter, should not be governed by highest moral and ethical standards.  Indeed, the ResPublica report is written from Aristotelian ‘virtue theory’ perspective that could be applied as a resource for reforming the culture of the banking industry.  ‘Virtue theory’ recognizes that people’s needs are different and virtue in banking would be about meeting the diverse needs of all, not just the needs of the few.

The main contribution of the “Virtuous Banking” report is to bring the concepts of morality and ethical frameworks into public discourse.  Such discourse is laudable but we should be under no illusion that changing the culture of the financial services industry will be a long process. Taking an oath will not change an individual’s moral and ethical worldview or behaviour.  The only way ethical and moral conduct can be reintroduced back into the banking sector is if the people who work in the industry were to hold themselves intrinsically to the highest ethical and moral standards.

Bankers operate within tight regulatory frameworks; the quickest way to drive behavioural change is therefore through regulatory interventions.  However, banking is already the most regulated industry known to man and regulation has not produced any sustainable change in the banks’ conduct.  One of the key problems with prevailing regulatory paradigms is that regulation limits managerial choice to reduce risk in the banking system, rather than focuses on regulating the drivers for managerial decision-making.

Market-based regulations that do not punish excellence but incentivize bankers to seriously think through the risk-return implications of their business decisions, will be good for the financial services industry and the economy as a whole.  A regulatory approach that makes banks and bankers liable for their decisions and actions through mechanisms such as bonus claw-back clauses will be more effective in reducing moral hazard at the systemic level and improving individual accountability at the micro level than taking a “Hippocratic” bankers’ oath.