On my way to Gatwick Airport to participate in a conference in Riga (Latvia) on economic challenges faced by the Baltic countries, I noticed a sign post for the village of Pratts Bottom. It reminded me of why I love living in this country. I am sure I really could find Little Whinging in Surrey if I looked long enough.

This naturally brings us to the question as to whether the Bank of England subsidises the banks through its newly created Special Liquidity Scheme (SLS). The scheme is a swap of one-year maturity Treasury Bills for illiquid mortgage-backed securities, covered bonds (Pfandbriefe), and asset-backed securities backed by credit card receivables. Let’s refer to this collection of bank assets as MBS (for mortgage-backed securities). (more…)

The actual baby turns out not to be too different from the one expected.  The Bank of England is now wholeheartedly committed to acting as market marker of last resort for systemically important securities for which the markets have become illiquid, not to say defunct, since the start of the crisis in August 2007.

The market maker of last resort provides market liquidity in the transactions-based model of financial capitalism the same way the lender of last resort provides funding liquidity to banks in the relationships-based model of financial capitalism.  The same institution, the central bank, can play both roles. All real-world versions of financial capitalism are convex combinations of the transactions-based model and the relationship-based model.  The relative weight on the transactions-based model is highest in the US and the UK.  Anne Sibert and I called for the Bank of England and other central banks to act as market makers of last resort on August 12, 2007, when the crisis had barely hatched from the wind egg of the financial bubble of 2003-2006. (more…)

The Bank of England and HM Treasury are likely to announce a package to take some illiquid assets off the banks’ balance sheets. It is hoped that this measure will (a) encourage the banks to engage in more mortgage lending to homeowners and (b) will help unfreeze the markets for residential mortgage backed securities (RMBS) that have been dead since last August. The amount involved is rumoured to be about £50 billion, an amount equal to just under half the net home lending in the UK last year, and probably close to the amount of net home lending we will see in 2008 (even with the injection of Treasuries that will be announced). (more…)

The failures of the western financial models

The worst outcome of the current financial crisis would be a return to the status quo ante that produced the pathologies, anomalies and contradictions that are its root causes.

I believe that the Western model of financial capitalism - a convex combination of relationships-based financial capitalism and transactions-based financial capitalism - has, in its most recent manifestations (those developed since the great liberalisations of the 1980s), managed to enhance the worst features of these two ideal-types and to suppress the best. This period has been characterised by a steady increase in the relative dominance of the transactions-based financial capitalism model in the overall financial arrangements of the world, most spectacularly in the US, the UK, and such smaller countries like New Zealand and Iceland, somewhat less in most of continental Europe and elsewhere. (more…)

In today’s Daily Telegraph there is a column of mine that proposes turning the Debt Management Office of the United Kingdom, a branch of HM Treasury, into a full-fledged Sovereign Portfolio Management Office or Sovereign Wealth Management Office.

The purpose is to kill two birds with one stone: (1) to get the state to invest in residential mortgage backed securities (RMBS) to unclog that market and restore access of first-time buyers to mortgage financing; (2) to get the state to issue more index-linked long-term debt and other useful instruments, like longevity bonds (bonds whose coupon or interest rate is tied to the survival rates /life expectancy of particular age cohorts). Longevity bonds index-linked to the CPI or to average earnings would be especially useful for pension funds and other institutional investors that are short longevity risk. (more…)

When I hear or read the words ‘off-balance-sheet financing’ or ’special purpose vehicle’, warning lights begin to flash and I grab for my obfuscatometer. Off-balance-sheet financing is any form of funding that avoids placing the owners’ equity, liabilities or assets on the balance sheet of a firm or other legal entity. The most common way to achieve this is by placing those items on some other entity’s balance sheet. A standard approach is to create a special purpose vehicle (SPV) and place assets and liabilities on its balance sheet. An SPV is a firm or other legal entity established to perform some narrowly-defined or temporary purpose.

There are circumstances (possibly as many as one percent of the reported occurrences of SPVs), where such entities are created to achieve true efficiency gains. For instance, creating a separate legal entity for certain activities may better align incentives for risk-sharing or may avoid conflict of interest. The overwhelming majority of SPVs are, however, created for nefarious and/or dishonest purposes: evading or avoiding regulation (and associated financial burdens and constraints or reporting obligations); tax avoidance or tax evasion; accounting shenanigans, including the circumvention of ceilings on the budget deficit or debt of public entities; and hiding assets or liabilities from scrutiny by interested parties. These often clever schemes are always economically equivalent to a much more straightforward on-balance-sheet arrangement. (more…)

The Institute of International Finance,  an organisation representing many of the world’s largest banks and other financial companies, has issued a pretty frank mea culpa for the litany of errors of omission and commission perpetrated by its members during the financial boom that turned to bust in August 2007.  The Interim Report of the IIF Committee om Market Best Practice states a large number of home truths and makes a host of useful suggestions about risk management, liquidity managements, compensation of senior bankers and superstars, over-reliance on formal quantitative models etc.

The tone of the report is one of “We know we screwed up, but now we’ve learnt our lesson (really we have!!) and we’ll never do it again; so there is no need to regulate us more severely and intrusively”. (more…)

The United Kingdom has been blessed since 1997 with an exemplary division of labour between the government of the day and the central bank. The government makes fiscal policy, sets the inflation target and appoints all but two members of the nine-member Monetary Policy Committee of the Bank of England. The remaining two members of the MPC are appointed by the Governor of the Bank of England after consultation with the Chancellor of the Exchequer. The Bank of England sets Bank Rate to pursue its legal mandate, as stated in the Bank of England Act 1998.

Operational independence for monetary policy was granted to the Bank of England in 1997 by the then Chancellor of the Exchequer, one Gordon Brown. This good Gordon no longer holds the job of Chancellor, and I have no idea what became of him.

For the benefit of his successor, and of the current prime minister - a man who strangely enough carries the same name as the 1997 Chancellor of the Exchequer but is in no way related to that far-sighted institutional innovator - let me restate the legal mandate of the Bank of England: (more…)

Mr Greenspan’s apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince.

1. The Greenspan Fed (August 1987 - January 2006) did indeed contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
2. The Greenspan-Bernanke put is real. It is an example of an inappropriate monetary policy response to a stock market decline.
3. The Greenspan Fed focused erroneously on core inflation, rather than using all available brain cells to predict underlying headline inflation in the medium term.
4. The Greenspan Fed failed to appreciate the downside of the rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for its undoubted virtues.
5. The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
6. The Greenspan Fed, by enabling the rescue of Long Term Capital Management in 1998, acted as a moral hazard incubator.
7. The failure of the Greenspan Fed to press, before or after LTCM, for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail, demonstrates either bad judgement or regulatory capture.
8. During his years as Chairman of the Federal Reserve Board, Mr. Greenspan’s statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator. Mr Greenspan’s theories have been comprehensively refuted by the financial crises of 1997/98 and 2007/08. (more…)

This blog is a comment on Martin Wolf’s Column in the Financial Times of Friday April 4, 2008, “Four falsehoods on immigration”.

Martin and I have crossed swords before on the issue of immigration. Our disagreement is fundamental and based on different ethical premises. Martin believes that existing residents of a country have a right to control who enters their country. The House of Lords select Committee shares this view, as is clear from their Report, The Economic Impact of Immigration, which asserts that the criterion to be used to assess the costs and benefits of immigration for the UK is the impact on the existing resident population.

I reject that view. The wellbeing of the existing resident population is no more, and no less, relevant than the wellbeing of any potential immigrant to the UK, wherever in the world he or she may be. I recognise private property rights. My home is my castle and I can deny entry into it to anybody at any time. I don’t recognise national property rights. A country is not like a private home. A country is an open club.

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