The Banker's Cautionary Tale

Endangered Species

And you thought the UK banking regulators were overbearing. Certainly not compared to Nigeria, where the Central Bank just fired and replaced the CEOs of 5 of the biggest banks.

We can barely wrap our minds around the monumental governance implications of this. However, it’s apparently normal in Nigeria. The country of 150 million people has only 24 banks, because the Central Bank decided by fiat that there were too many small banks, and mandated merger or liquidation for the entire sector.

The lesson here is that when regulators and politicians start to make populist decisions that should be made by markets, a slippery slope is begun. Eventually, policy actions that would once have seemed unthinkable become normal- with dire consequences for the Way of the Capitalist.

And The Way is in greater peril than ever. On one flank is Europe, gleefully gloating as it hopes to drag the UK into its socialist community of high unemployment, stratospheric taxes and government micromanagement. Inside our borders are fifth columnists like Compass, furiously lobbying the government to set bankers’ pay.

And across the ocean are the salivating financial sectors of Asia, Africa, South America and Eastern Europe, just waiting to snap up the cream of London’s financial sector if this happens. Capital goes where it will earn the best returns, and as the British Bankers’ Association has warned, if this perilous trend continues the UK’s loss will be the world’s gain.

Lion's Den: How Not to Manage Change

Grappling with the status quo

President Obama has dispatched the cream of his Democratic party to far-flung corners of the country to sell his healthcare reform plan. The result has been near-lynchings, as furious assemblies of ordinary citizens almost literally tried to shoot the messenger.

They are reacting to rabble-rousing rumors of a grand scheme to plunge the country into the arms of a costly socialist experiment, in which ‘Death Panels’ would do the citizenry into their graves.

Alas, Fear, Uncertainty and Doubt often bolster the Case for No Change. FUD merchants have claimed that the UK system of universal health-care is an evil blister on society, forcing our politicians to valorous defense.

President Obama is moon-walking blithely into the fray, confident of his calming charisma. But he is calming a storm that shouldn’t have arisen in the first place.

People are still terrified by the financial crisis, and change is always disconcerting. The town hall meetings should have happened before any policy was proposed. Then, people would feel they were crafting a policy, rather than reacting to a fait accompli. They would have had time to discuss the facts, air their apprehensions, warm to the idea of change.

Whatever the merits or otherwise of Obama’s proposals, the current firestorm of resistance is a salutary one to all change managers. It’s much easier to prevent a fire than to quench one.

New Scrap for Old

Valuable Asset

‘Cash for clunkers’ is the catchy moniker for the subsidy that’s all the rage. Everyone loves it- a worrisome development, seeing as it comprises three things that should ordinarily never mix: politicians, public money and a good cause.

The UK government started the dangerous experiment by paying people £2,000 to trade in their old cars for newer, environmentally-friendlier ones. Predictably, people started buying new cars because they were getting them at a perceived discount.

We say ‘perceived’, because no-one considered the real cost. The Americans, desperate for positive PR as the Obama administration was bludgeoned by a brutal national healthcare debate, promptly allocated $1bn to bribing the populace.

The first billion disappeared like a courtesan’s dollar bill, resulting in a follow-up tranche of $2bn. Dying carmakers like Ford love the lifeline’s respite from annihilation. Now, even Russia is offering roubles for wrecks.

Let’s pause and think calmly before this party gets out of hand. This scheme merely makes people buy today cars they might have bought tomorrow, meaning overall demand stays flat. Secondly, the perceived discount is a mirage- they’re really paying full price, partly from their income and partly via taxes.

The auto companies too get a mixed blessing: they will over-invest in capacity for green vehicles, and discover that when the subsidies end, there will be no takers for their stock. And those that should have died a merciful death today will have their death throes pointlessly prolonged.

Cheap Money-but to what end?

Holding back the flow

The markets fidgeted nervously over the past two days, as the Fed met in secret conclave to deliberate on the direction of monetary policy.

It needn’t have worried: The Fed Funds rate, which influences all other US interest rates, remains at essentially zero. With U.S. unemployment now at a disturbing 9.5%, the Fed fears that curbing the flow of cheap money might constrain investment and spending, and plunge the already feeble economy into the waiting arms of the Grim Reaper.

The Bank of England Chairman agrees. With the key UK interest rate at a similar level of 0.5%, the Chief Money Man paints a gloomy picture of the economy’s prospects. With unemployment now at 2.4 million Britons or 7.6%, the faltering monetary system needs all the boost the BoE can muster.

Or so the conventional wisdom goes. Like the massively unaffordable bailouts, this loose monetary policy is a short-term band-aid with potentially dire future consequences. By keeping interest rates low, central bankers are encouraging consumers to maintain high debt levels. Unaffordable mortgages and credit card debt remains unpaid. Eventually, interest rates will have to rise- and the burden of their repayment will be even heavier then.

It would be more merciful to gradually raise interest rates now. This would hasten the return of house prices to normal levels, force weak borrowers into bankruptcy and purge bank balance sheets of bad loans in one swift, bloody pass. The sooner the purge, the quicker the recovery.

Putting in the Screws

Tax Time!

“Government is the great fiction, through which everybody endeavors to live at the expense of everybody else.”   -Frederic Bastiat

There are no atheists in foxholes, and no free-marketers in a financial crisis. Which is unfortunate

In booming times, people are understandably chary of government interference in their lives. However, amidst a perfect storm of financial misery such as we’ve witnessed over the past year, the robust teat of government nourishment becomes irresistible.

The problem is, the idea of government help is an illusion. When we say ‘the government pays’, we project a paternal omnipotence on it as a source of unlimited resources. In truth, all government does is redistribute our own tax money.

Council housing, we all pay. ‘Free education’, we all pay. The NHS, we all pay. Unemployment benefits, we all pay. This is why, when the government moves to heroically ‘rescue’ the financial system at a cost of trillions, we should resist the urge to outstretch our hungry hands, and instead ask: but who will pay for it?

Because the truth is, we will. The IMF reports that the credit crunch has cost governments (i.e. us) $10 trillion. Of the G20 countries, the UK will suffer the largest resulting budget deficits- 99.7% of GDP by 2014. The government (i.e. we) will owe almost as much money as the entire economy generates.

This explains why the tax authorities are beginning to put in the screws– they need cash from us to settle the bailout bills. They’re also considering cracking down on private landlords who take in lodgers for a bit of spare cash. The squeeze has just begun. Pay we will.

Google: Better Mousetrap or Better Brand?

Best technology or best brand?

What is the world’s best search engine? You’d probably reply, Google. But is it really?

That reply is akin to saying that Coke is the world’s best soft drink or McDonald’s makes the world’s best hamburger. It’s the one you’re most likely to choose, but the best? Probably not.

This is the power of successful brands: by positioning in the public’s head as the preeminent choice, they generate loyalty out of proportion to their actual product superiority.

Google was recently adjudged the world’s most valuable brand. The Google logo itself is worth $100bn, because people are more likely to choose a product with the Google brand plastered across it, even when it isn’t significantly better than alternatives.

One informal way to test this is a search engine blind test. You enter a search term into the box, click it and three blind searches from Google, Yahoo and Microsoft’s Bing are displayed. You choose which you think is the best, and it then reveals the answers. They may surprise you.

Despite Yahoo’s assertion that it’s not a search engine, in our tests it consistently provided the best search results. Google was a distant second, with Bing dead last. Hardly scientific, but with Google holding 78% of US searches (to Yahoo’s 11% and Bing’s 8%), it is unlikely that this market dominance is explained solely by the superiority of Google’s product.

What did YOU find?

The End of Free Internet Stuff?

Endangered Species...

Free stuff on the Internet has been a proud and venerable tradition. Is this noble custom under threat?

The rise of the Internet decimated the ranks of all manner of traditional businesses. Just as record companies were settling into the sweet spot of selling high-margin CDs, music sharing networks turned digital piracy into an art form, and the public loved it.

Next to falter were traditional newspapers, gutted by the rise of free news websites. Now, no information industry is safe from the depredations of Internet Robin Hoods, who would take from the strategically flat-footed and give to the cheapskate.

The web offered the means to share information digitally, but legacy business models did not allow for online distribution. So people simply stole stuff and shared it in the cloud. Before long, it was essential to give content away for free merely to have a web presence.

But because content always cost money to create and publish, it was never really cost-free. The question was, who would have the courage to charge for it?

Premium publications like The Economist and the Wall Street Journal have been doing just that. Now, News Corp Emperor Rupert Murdoch signals that his online newspapers will stop giving away the goods . Despite skepticism about whether he can get away with it, the venerable Financial Times swiftly echoes the refrain.

Whatever has value can command a price- even on the Internet. The web may finally be growing up.

The Politics of Power

No kidding

The business of energy has always been fraught with fear and loathing of a political kind. With the UK’s North Sea oil reserves in decline, the old night terrors are coming back.

The Economist explains the UK’s dilemma: 31% of the UK’s energy comes from the evil, climate-destroying coal, and 46% from natural gas. However, the government’s commitments to green targets means new coal plants are anathema. But with North Sea gas reserves in steep decline, where will the shortfall be made up from?

The answer is simply, Russia. The Great Bear is Europe’s largest potential supplier of natural gas, and this makes many people (including The Economist) uncomfortable. Russia hasn’t helped allay this nervousness by playing hardball politics with its gas supplies in the past.

The anti-Russian xenophobia is reminiscent of America’s nervousness about its ‘dependence on foreign oil’. The 1973 and 1976 oil price shocks created an eternal terror in the US that the Persian Gulf producers will use oil as a political tool, and has been the single bigggest driver of US foreign policy after the anti-Communist Cold War.

Meanwhile, Russia blithely continues to sign supply contracts with the likes of Turkey. This shows why the terror is overblown: Russia needs to sell its gas just as the Arabs need to sell their oil. They may bluster and posture occasionally to get respect, but permanently restricting supply would be shooting themselves in the foot.

Politicians may preen, but profits will rule at last.

British Kidneys for British Patients

Market Makers

If you were critically ill and needed a new kidney to live, how much would you pay for it?

Now, say you’re perfectly healthy and have two perfectly functioning kidneys. Some poor person, stricken with kidney disease by the gods, is willing to pay you for one of yours. How much would you sell it for?

Between those two figures is the sweet spot: the equilibrium price for your kidney. Now, if you aggregate each UK citizen’s demand and supply conditions, you get the UK’s equilibrium price for kidneys.

At this market-clearing price, everyone who wants a kidney will get one, and everyone willing to sell theirs will receive a fair price.

This situation would save lives, and avoid the inefficient overstocking of perfectly good kidneys. All that would be required is a suitable electronic exchange for trading kidneys, brokers to match buyers and sellers, and a settlement mechanism.

This successful market could then be extended to include international kidney arbitrage. A Ukrainian with a perfectly good kidney could check his Bloomberg screen for the forward price for his kidney in say six months, and buy a put option to save a Briton on dialysis from death.

But not if the government can help it. The Over-the-Counter market for kidneys has been banned. Presumably, Apple CEO Steve Jobs’ recent acquisition of a new liver was thought not in good taste.

Why would we rather see people die for lack of donor organs than facilitate the market we describe above?

Bonus Issues

It’s not a good time for socialism. Having lost the greatest ideological debate of the 20th century, it looked to be making a brief comeback during the credit crunch. But now, defeat is certain at the avaricious hands of committed capitalists everywhere.

One of its last, futile acts of defiance was the recent US Congress vote to curb ‘excessive’ bank bonuses. Ironically, as laws go, it was actually quite a good one. By giving shareholders the right to non-binding votes on executive pay, it shifted the skewed balance of power slightly away from management and more in favour of shareholders.

The problem is that although the effect was desirable, the motive was decidedly scurrilous. In service economies like the US and UK, the price of people is the primary signal for allocating capital.

Like a modern slave market, the specimen with the most robust MBA commands the highest price at auction. Once you start meddling with bonuses, the runt of the litter starts commanding the same distorted price as the chap with the Atlas physique.

The most encouraging sign is that, now that banks like Goldman Sachs, Barclays and HSBC have started reporting profits akin to the loot of old, they are shaking off the shackles of shame imposed on them by an envious public, and returning to their old ways. As Barclays defiantly announced the return of bumper bonuses, a line was drawn in the sand. Regulators blinked. Capitalism won.