Dear Mr. Wolf,
Thanks for your article in today's Financial Times.
In the article, you mention that "shareholder value maximisation and the market in corporate control also bring benefits: the takeovers liberate assets from the hands of incompetent managers and so should frighten them into action". Earlier in the article you also mention that "companies exist to provide valuable goods and services to their customers"
If companies exist as you say to provide valuable goods and services to their customers, then the success of failure of a company and its management should be primarily judged by the customers, by customers not buying/rejecting their products in the market place. I believe that is only fair.
So, the comprehensive system is not to have the empire-building CEO's with the help of investment bankers to take-over and destroy companies built over decades but to have the frame-work for good and fair competition and let all the stake-holders including customers decide.
The argument that 'companies do not have to go public. If they do, they live by the markets' judgement' is good only when you add fair-regulation to the issue.
Coming back to this specific case of Kraft & Cadbury, with more than $30 billion of debt in this economic environment, what this deal has done is as you say just made the management, share-holders of Cadbury and Investment Bankers rich. The stake-holders who will primarily suffer is the employees and in the long-run customers.
When I was in primary school, I was taught that company means 'breaking bread together' - that is where people come together to build goods and services to serve their customers and in the process get a decent livelihood for themselves. That was true 200 years ago and it is true today. The job of the regulation is to make sure that balance between all the stake-holders in a company like employees, customers and share-holders is always maintained. Just saying that "markets' judgement" is ultimate shows not just ethical but cultural decadence. It makes me sad when it comes from distinguished and knowledgeable authors like yourself.
Regards,
Pradeep Kabra
-------------------------------------------
Britain’s strategic chocolate dilemma
By Martin Wolf
Published: January 28 2010 20:19 | Last updated: January 28 2010 20:19
Briefly, during the takeover bid for Cadbury by Kraft, I thought the UK might proclaim a “strategic chocolate” doctrine. Fortunately, that did not happen. Less fortunately, if history is any guide, the takeover of Cadbury is quite likely to be a flop. If so, the winners will be the shareholders of Cadbury, the advisers for both sides and those who arranged the loans. The right question, then, is not about chocolate. It is about the market in corporate control itself.
For high priests of Anglo-American capitalism, this question is heresy. They would insist that shareholders own the business and have a right to dispose of their property as they see fit. They would add that an active market in corporate control is an essential element in “shareholder value maximisation”, on which an efficient market economy rests. Yet, after financial markets have gone so spectacularly awry, the question whether companies should be left to the markets is being raised.
The response to the first of these arguments is that ownership rights are never absolute. In fact, the ownership of companies by their shareholders is highly diluted, as my colleague, John Kay, has noted on several occasions.
Shareholders enjoy limited liability. As a result, the responsibility they bear for the malfeasance or incompetence of management is highly circumscribed. The claim of shareholders is solely on the residual income of the company. But, since shareholders can diversify their portfolios with ease, their exposure to the risks generated by an individual company is far less than the exposure of workers with firm-specific knowledge and skills. Shareholders lack the ability to assess or monitor a company’s performance. If they are able to sell their shares in liquid markets, they do not have incentives to do so either. Failures of corporate governance in widely held public companies are, it follows, inevitable.
As problematic as the notion of shareholder ownership is the recommendation to maximise shareholder value. Harvard university’s Michael Jensen has argued that “in the absence of externalities [and when all goods are priced] social welfare is maximised when each firm in an economy maximises its total market value”. This is a statement of the efficiency properties of perfect markets. But markets are imperfect, not least financial markets. They can lead managers in what prove to be wealth-destroying directions: just consider the stock market bubbles in Japan in the late 1980s and the US in the late 1990s. Companies exist to provide valuable goods and services to their customers. The market’s evaluation of profitability may well be a defective measure of progress towards this broader objective.
This general point has particular force for the market in corporate control. As we have known since the Nobel-winning work of Ronald Coase, companies exist because hierarchies are superior to markets. One reason for this is the cost of defining and monitoring specific contracts. Instead of detailed contracts, long-term relationships based on trust need to emerge inside businesses and between businesses and suppliers. But the knowledge that management may be ousted by opportunistic buyers could well act as a disincentive to forming such relationships in the first place. Everybody will then become an opportunist. If so, the companies likely to thrive are those for which these relationships are unimportant. An active market in corporate control might distort a country’s comparative advantage and even undermine its long-term success.
Evidently, there exist countries with highly successful companies – Germany and Japan come to mind – that do not permit an active market in corporate control. For the Japanese, the idea of selling a company over the heads of its management is as ridiculous as that of selling their mothers. In these eyes, a company is a social institution with wide obligations, particularly to long-term employees, not an entity to be bought and sold.
Yet shareholder value maximisation and the market in corporate control also bring benefits: markets may be imperfect, but they are arguably the least bad measuring rod; shareholder value at least gives a company a clear criterion; and the takeovers liberate assets from the hands of incompetent managers and so should frighten them into action.
Since a market in corporate control will never be a global norm, we enjoy the benefit of learning from a natural experiment. There is no theoretically correct answer, but we can learn from the corporate performance of countries with divergent approaches.
Where does this leave the UK? A shift to more restrictive British takeover rules is most unlikely to help. We need only think back to the dismal performance of UK companies in sleepier times. If that means we have to swallow the takeover of a Cadbury by a Kraft, so be it: strategic chocolate should not be on the agenda. Companies do not have to go public. If they do, they live by the markets’ judgment. In the UK, shareholders rule.
martin.wolf@ft.com
More columns at www.ft.com/martinwolf
--------------------------------------
Could we post this excellent comment on our economists' forum?
Martin Wolf
--------------------------------------
Hi Pradeep,
Good comments, keep it up.
Regards,
Kamlesh
---------------------------------------
Well done, Pradeep.
I personally feel that this Kraft/Cadbury business is a disgrace. I fear that the great ethical basis that the Quaker Cadbury founders held will be discarded very quickly, quite possibly along with the well-regarded quality of the Cadbury group products.
Furthermore, surely a debt-based takeover like this is not one jot more ethical than the toxic international banking system has recently fallen into.
Kind regards
Clive
--------------------------------------
Friday 29 January 2010
Tuesday 26 January 2010
Re: Too early to write off democracy in China
Dear Mr. Skapinker,
Thank you for your article in todays Financial Times.
Couple of things I find amusing in your article - "Successful economies depended on the free exchange of ideas. Innovation came from the clash of competing products and services with consumers free to choose the best"
Just to give you one example, I don't see that in the sports television in UK - where Sky dominates not by any innovation but by having the sole rights. If your remarks are true then the way sports should be auctioned is have 2-3 networks the ability to show the games with superior commentary team or HD close-up views/replays or ability to watch the highlights online etc can be called as innovations to attract and keep customers. But that doesn't happen.
Secondly, in the Western world less than 50% people on average vote. Where is the universal suffrage?
Finally, though you have passingly mentioned that India is an imperfect democracy - the fact is democracy is actually the bane of India in practical terms. I know this sounds as if I'm somebody from an communist era but that is not true. In the present day India, 40% of the country is run by Naxalites. The government has no control whatsoever. Due to frequent elections, the politicians gets elected and pay themselves and their cronies off and then they give way to the next lot all in the name of Democracy.
The fact is Democracy in Western style is OK for one set of conditions i.e., good physical infrastructure, educated population etc., For the poor parts of the world, the Chinese model is what works. We have been seeing the Chinese miracle for the last 20-30 years up-close. Nobody can deny it. Yes, there needs to be a common denominator to deal with West for the Chinese & other third-world countries but setting the rules for the common denominator is not the way ahead. That is where most of the Western commentators go wrong. The key is to understand them with an open mind. Comparing communist Russia with present day China is as misleading as comparing the world's largest democracy (India) with the richest (USA).
Regards,
Pradeep Kabra
----------------------
Too early to write off democracy in China
By Michael Skapinker
Published: January 25 2010 20:41 | Last updated: January 25 2010 20:41
At the South African university I attended during the apartheid years, several of my fellow students disappeared during the night. Taken away by the police, they were held in solitary confinement, without access to lawyers, family or reading matter, for weeks and sometimes for months. A few were tortured.
Yet, being white, we were mostly a lucky bunch. We enjoyed an excellent standard of living and a fine education. There was anxiety about who at the university might be police informers, but for us, the security apparatus was never as all-enveloping as it was either for black South Africans or for those living in communist dictatorships.
But the experience left me with an enduring commitment to democratic government and the rule of law, and a horror of unaccountable authority.
Both apartheid and Soviet communism have, happily, collapsed and South Africa has, equally happily, opted for parliamentary constitutionalism over the communism of many of apartheid’s opponents.
More than 50 years ago Richard Nixon, then US vice-president, and Nikita Khrushchev, the Soviet leader, argued in a mocked-up American kitchen in Moscow about whose system was superior. By the time the Soviet empire imploded in the late 1980s, the answer was obvious.
Democratic countries were better. Not only were their people freer; they were more prosperous.
How could they be otherwise? Successful economies depended on the free exchange of ideas. Innovation came from the clash of competing products and services, with consumers free to choose the best.
A successful economy was also impossible without an independent legal system, which ensured that people’s property, both physical and intellectual, could not be stolen by criminals or government cronies.
Yet democracy was not easy. Russia may no longer be communist but it is hardly a model democracy either. Iraq and Afghanistan are proof that democracy cannot be imposed from outside.
Nor does it always produce the expected results. As a letter writer pointed out in the Financial Times on Friday, democracy is viewed as dysfunctional in the Philippines and has failed to produce stability in Thailand.
Run your eye down the list of wealthiest countries as measured by gross domestic product per capita. Alongside democracies such as the US, Switzerland, Austria and Canada are less-than-democratic Qatar and Brunei, as well as semi-democracies like Hong Kong and Singapore.
Does this invalidate the economic case for democracy? Not entirely. Qatar and Brunei would not be there without oil and gas. Hong Kong and Singapore inherited their legal institutions from Britain. They are rare examples of the rule of law co-existing with less than vigorous political systems. Their model is even harder to emulate than full-blown democracy.
Look at it another way. The countries that achieve scores of more than 90 per cent on both the World Bank’s Worldwide Governance Indicators “voice and accountability” and its “rule of law” ratings are all prosperous (although one, Iceland, is admittedly in serious trouble). Most of those scoring below 20 per cent on both are deeply impoverished.
What of countries on the way to becoming prosperous? Of the Bric countries, two – India and Brazil – are democracies, albeit imperfect ones. During a visit to Brazil last year I met many people who pointed to the country’s democracy as a key to its progress. As for Russia, it is heavily dependent on oil and gas exports and some have said it does not really belong in the Bric group.
It is China, now the world’s third largest economy and tipped to become the largest by 2041, that is the democrat’s biggest challenge. Unlike the Soviet Union, it appears to have found a way to lift millions out of poverty while still locking up its dissidents. Many have pointed toChina’s clash with Google over censorship as evidence that the country will not become more democratic as it prospers.
Perhaps, but this story has a long way to run. China may, within the next few decades, become the world’s biggest economy, but it will take far longer for it to have the world’s richest people. Measured by per-capita gross domestic product, International Monetary Fund estimatesput China behind Armenia in 2008.
It was the Chinese leader Zhou Enlai who, asked for his assessment of the French revolution, is reputed to have said that it was too early to tell. Whether he actually said it or not, it is certainly too early to tell what the consequences of China’s economic revolution will be.
Perhaps the Chinese people will be content, one day, to be rich and unfree. But the hunger for liberty is strong, and it is not confined to any time or place.
Send your comments to michael.skapinker@ft.com
More columns at www.ft.com/skapinker
-----------------------------
Dear Pradeep,
Many thanks for your email.
I take many of your points, but if, as you say, for poorer countries, it's the Chinese model that works, where are the other examples of the Chinese model (one party dictatorship, semi-market economy) working?
Regards,
Michael
-----------------------------
Dear Mr. Skapinker,
Then what is the way ahead?
Presently all the 'rogue' nations are either shunned or lectured by the West which makes no difference whatsoever to the final outcome. What China is doing is building the platform for the Chinese model by starting to build their infrastructure without worrying about human rights or proper way of doing things.
I'm pretty sure once the infrastructure is set and the population doesn't go to sleep hungry, then they aim to get educated. The so-called political freedom is bound to follow.
Hopefully you will focus on few of these issues in your future articles.
Regards,
Pradeep
--------------------------
Thank you for your article in todays Financial Times.
Couple of things I find amusing in your article - "Successful economies depended on the free exchange of ideas. Innovation came from the clash of competing products and services with consumers free to choose the best"
Just to give you one example, I don't see that in the sports television in UK - where Sky dominates not by any innovation but by having the sole rights. If your remarks are true then the way sports should be auctioned is have 2-3 networks the ability to show the games with superior commentary team or HD close-up views/replays or ability to watch the highlights online etc can be called as innovations to attract and keep customers. But that doesn't happen.
Secondly, in the Western world less than 50% people on average vote. Where is the universal suffrage?
Finally, though you have passingly mentioned that India is an imperfect democracy - the fact is democracy is actually the bane of India in practical terms. I know this sounds as if I'm somebody from an communist era but that is not true. In the present day India, 40% of the country is run by Naxalites. The government has no control whatsoever. Due to frequent elections, the politicians gets elected and pay themselves and their cronies off and then they give way to the next lot all in the name of Democracy.
The fact is Democracy in Western style is OK for one set of conditions i.e., good physical infrastructure, educated population etc., For the poor parts of the world, the Chinese model is what works. We have been seeing the Chinese miracle for the last 20-30 years up-close. Nobody can deny it. Yes, there needs to be a common denominator to deal with West for the Chinese & other third-world countries but setting the rules for the common denominator is not the way ahead. That is where most of the Western commentators go wrong. The key is to understand them with an open mind. Comparing communist Russia with present day China is as misleading as comparing the world's largest democracy (India) with the richest (USA).
Regards,
Pradeep Kabra
----------------------
Too early to write off democracy in China
By Michael Skapinker
Published: January 25 2010 20:41 | Last updated: January 25 2010 20:41
At the South African university I attended during the apartheid years, several of my fellow students disappeared during the night. Taken away by the police, they were held in solitary confinement, without access to lawyers, family or reading matter, for weeks and sometimes for months. A few were tortured.
Yet, being white, we were mostly a lucky bunch. We enjoyed an excellent standard of living and a fine education. There was anxiety about who at the university might be police informers, but for us, the security apparatus was never as all-enveloping as it was either for black South Africans or for those living in communist dictatorships.
But the experience left me with an enduring commitment to democratic government and the rule of law, and a horror of unaccountable authority.
Both apartheid and Soviet communism have, happily, collapsed and South Africa has, equally happily, opted for parliamentary constitutionalism over the communism of many of apartheid’s opponents.
More than 50 years ago Richard Nixon, then US vice-president, and Nikita Khrushchev, the Soviet leader, argued in a mocked-up American kitchen in Moscow about whose system was superior. By the time the Soviet empire imploded in the late 1980s, the answer was obvious.
Democratic countries were better. Not only were their people freer; they were more prosperous.
How could they be otherwise? Successful economies depended on the free exchange of ideas. Innovation came from the clash of competing products and services, with consumers free to choose the best.
A successful economy was also impossible without an independent legal system, which ensured that people’s property, both physical and intellectual, could not be stolen by criminals or government cronies.
Yet democracy was not easy. Russia may no longer be communist but it is hardly a model democracy either. Iraq and Afghanistan are proof that democracy cannot be imposed from outside.
Nor does it always produce the expected results. As a letter writer pointed out in the Financial Times on Friday, democracy is viewed as dysfunctional in the Philippines and has failed to produce stability in Thailand.
Run your eye down the list of wealthiest countries as measured by gross domestic product per capita. Alongside democracies such as the US, Switzerland, Austria and Canada are less-than-democratic Qatar and Brunei, as well as semi-democracies like Hong Kong and Singapore.
Does this invalidate the economic case for democracy? Not entirely. Qatar and Brunei would not be there without oil and gas. Hong Kong and Singapore inherited their legal institutions from Britain. They are rare examples of the rule of law co-existing with less than vigorous political systems. Their model is even harder to emulate than full-blown democracy.
Look at it another way. The countries that achieve scores of more than 90 per cent on both the World Bank’s Worldwide Governance Indicators “voice and accountability” and its “rule of law” ratings are all prosperous (although one, Iceland, is admittedly in serious trouble). Most of those scoring below 20 per cent on both are deeply impoverished.
What of countries on the way to becoming prosperous? Of the Bric countries, two – India and Brazil – are democracies, albeit imperfect ones. During a visit to Brazil last year I met many people who pointed to the country’s democracy as a key to its progress. As for Russia, it is heavily dependent on oil and gas exports and some have said it does not really belong in the Bric group.
It is China, now the world’s third largest economy and tipped to become the largest by 2041, that is the democrat’s biggest challenge. Unlike the Soviet Union, it appears to have found a way to lift millions out of poverty while still locking up its dissidents. Many have pointed toChina’s clash with Google over censorship as evidence that the country will not become more democratic as it prospers.
Perhaps, but this story has a long way to run. China may, within the next few decades, become the world’s biggest economy, but it will take far longer for it to have the world’s richest people. Measured by per-capita gross domestic product, International Monetary Fund estimatesput China behind Armenia in 2008.
It was the Chinese leader Zhou Enlai who, asked for his assessment of the French revolution, is reputed to have said that it was too early to tell. Whether he actually said it or not, it is certainly too early to tell what the consequences of China’s economic revolution will be.
Perhaps the Chinese people will be content, one day, to be rich and unfree. But the hunger for liberty is strong, and it is not confined to any time or place.
Send your comments to michael.skapinker@ft.com
More columns at www.ft.com/skapinker
-----------------------------
Dear Pradeep,
Many thanks for your email.
I take many of your points, but if, as you say, for poorer countries, it's the Chinese model that works, where are the other examples of the Chinese model (one party dictatorship, semi-market economy) working?
Regards,
Michael
-----------------------------
Dear Mr. Skapinker,
Then what is the way ahead?
Presently all the 'rogue' nations are either shunned or lectured by the West which makes no difference whatsoever to the final outcome. What China is doing is building the platform for the Chinese model by starting to build their infrastructure without worrying about human rights or proper way of doing things.
I'm pretty sure once the infrastructure is set and the population doesn't go to sleep hungry, then they aim to get educated. The so-called political freedom is bound to follow.
Hopefully you will focus on few of these issues in your future articles.
Regards,
Pradeep
--------------------------
Friday 8 January 2010
Re: Funding and the Patriotism Test
Dear Gillian,
Many thanks for the wonderful insight. You are one of the few journalist who is honest and speak with clarity.
My only issue is you have started the article with credit rating agencies prospective behaviour. I say that by doing this you are giving credibility to the rating agencies. The rating agencies job was to act like a guide to the real investors (not investment banking speculators). But they not just failed in their job but have deliberately misled them.
I would have thought that till the rating agencies are reformed (by removing the conflict of interest - the rating agencies are paid by the companies whose products they rate) the rating agencies should be totally ignored or ostracized. It doesn't matter what they think.
I hope you do not disagree.
Regards,
Pradeep Kabra
----------------------------
Funding and the patriotism test
By Gillian Tett
Published: January 7 2010 21:03 | Last updated: January 7 2010 21:03
In recent months, some of the brightest minds at Moody’s rating agency have been mulling a fascinating question: should they introduce a formal rating of “social cohesion” into sovereign debt indices, when they judge whether a government is likely to default on its debt – or not?
So far, neither Moody’s nor any other agency has actually done this, after all it is pretty hard to feed a specific “cohesion” number into any model.
But the discussion points to a fundamental issue that will hang over bond markets this decade.
In the past few years, when markets have tried to judge the risk attached to western government bonds, they have typically done so looking at hard macro-economic data, such as projected gross domestic product. Such data, of course, continue to be critically important, given the size of the western fiscal hole.
What is becoming clear is that hard numbers do not tell the entire tale. What will be equally crucial in the coming years is not the sheer scale of debt, but whether governments can implement a rational and effective way of cutting it – and potentially allocating pain – without unleashing (at best) political instability, or (at worst) full blown revolution.
Does a country, in other words, have enough political and social “cohesion” to take truly tough choices, or even rewrite the social contract? What makes that issue doubly fascinating is that the answer may well vary in different parts of the bond market, in the years to come.
At one end of the spectrum there is a country like Japan. A decade ago, I worked in Tokyo as a reporter and was often struck by the skill with which Japanese institutions shared out pain, without triggering social unrest. Whenever companies ran out of cash, for example, their instinct was usually to spread the impact (by, say, cutting everyone’s salary) rather than pick winners and losers (sack a few staff.)
Some observers blame that on Japan’s obsession with maintaining cultural harmony; many Japanese point to the fact that they live in an island with constrained resources. Either way, this emphasis on sharing pain in an equitable manner is likely to shape how the government tries to impose public spending cuts in future years.
It may impact bond market behaviour. One striking feature of the Japanese government bond markets in recent years is that domestic investors (who own 95 per cent of outstanding JGB stock) have continued to buy bonds, even amid ratings downgrades in the JGB market, with an extraordinary sense of quasi-patriotism. That is bad in some respects, since it removes pressure for change; but it may also make it less likely that Japan will rip itself apart.
However, in the US, the government has less experience of dividing up a shrinking pool of resources. Instead, in a land built by pioneers, Americans prefer to spend time thinking about how to make the pie bigger – or to find fresh frontiers – than about making shared sacrifices.
Thus it remains an open question whether Washington will be able to slash without real political or social upheaval. Signs of tension are already there: Bill Gross of Pimco, for example, this week warned that “our [American] government does not work any more; or perhaps more accurately, when it does it works for special interests and not for the American people”.
The situation of the UK is perhaps even more fascinating, given that it faces an election this year – and is at more immediate risk of a ratings downgrade. The British government has the “advantage” (if one can call it that) that voters are long used to the concept of national decline, and relatively recent memories of fiscal belt-tightening.
But social cohesion and patriotism in the UK are fragmenting, and investors in gilts are apt to be far less patriotic than in Japan (not least because only 50 per cent of the gilt market is in domestic hands).
So will UK politicians be able to implement radical reforms with a spirit of shared sacrifice? Or will they do what Icelandic voters have done this week – and derail a government plan? And how will gilt investors react, as a country such as the UK starts fighting this out, or loses its triple A credit rating?
Right now, the answer is simply unknown. But the key point is this: if the past two years were a crucial test for global financial markets, the next two will be an equally critical test for the system of western government.
Stand by to see plenty more volatility and uncertainty in the government bond markets. The really big risk factors, be it in Iceland or the UK, the US or Ukraine, can no longer be easily factored into a spreadsheet.
gillian.tett@ft.com
Many thanks for the wonderful insight. You are one of the few journalist who is honest and speak with clarity.
My only issue is you have started the article with credit rating agencies prospective behaviour. I say that by doing this you are giving credibility to the rating agencies. The rating agencies job was to act like a guide to the real investors (not investment banking speculators). But they not just failed in their job but have deliberately misled them.
I would have thought that till the rating agencies are reformed (by removing the conflict of interest - the rating agencies are paid by the companies whose products they rate) the rating agencies should be totally ignored or ostracized. It doesn't matter what they think.
I hope you do not disagree.
Regards,
Pradeep Kabra
----------------------------
Funding and the patriotism test
By Gillian Tett
Published: January 7 2010 21:03 | Last updated: January 7 2010 21:03
In recent months, some of the brightest minds at Moody’s rating agency have been mulling a fascinating question: should they introduce a formal rating of “social cohesion” into sovereign debt indices, when they judge whether a government is likely to default on its debt – or not?
So far, neither Moody’s nor any other agency has actually done this, after all it is pretty hard to feed a specific “cohesion” number into any model.
But the discussion points to a fundamental issue that will hang over bond markets this decade.
In the past few years, when markets have tried to judge the risk attached to western government bonds, they have typically done so looking at hard macro-economic data, such as projected gross domestic product. Such data, of course, continue to be critically important, given the size of the western fiscal hole.
What is becoming clear is that hard numbers do not tell the entire tale. What will be equally crucial in the coming years is not the sheer scale of debt, but whether governments can implement a rational and effective way of cutting it – and potentially allocating pain – without unleashing (at best) political instability, or (at worst) full blown revolution.
Does a country, in other words, have enough political and social “cohesion” to take truly tough choices, or even rewrite the social contract? What makes that issue doubly fascinating is that the answer may well vary in different parts of the bond market, in the years to come.
At one end of the spectrum there is a country like Japan. A decade ago, I worked in Tokyo as a reporter and was often struck by the skill with which Japanese institutions shared out pain, without triggering social unrest. Whenever companies ran out of cash, for example, their instinct was usually to spread the impact (by, say, cutting everyone’s salary) rather than pick winners and losers (sack a few staff.)
Some observers blame that on Japan’s obsession with maintaining cultural harmony; many Japanese point to the fact that they live in an island with constrained resources. Either way, this emphasis on sharing pain in an equitable manner is likely to shape how the government tries to impose public spending cuts in future years.
It may impact bond market behaviour. One striking feature of the Japanese government bond markets in recent years is that domestic investors (who own 95 per cent of outstanding JGB stock) have continued to buy bonds, even amid ratings downgrades in the JGB market, with an extraordinary sense of quasi-patriotism. That is bad in some respects, since it removes pressure for change; but it may also make it less likely that Japan will rip itself apart.
However, in the US, the government has less experience of dividing up a shrinking pool of resources. Instead, in a land built by pioneers, Americans prefer to spend time thinking about how to make the pie bigger – or to find fresh frontiers – than about making shared sacrifices.
Thus it remains an open question whether Washington will be able to slash without real political or social upheaval. Signs of tension are already there: Bill Gross of Pimco, for example, this week warned that “our [American] government does not work any more; or perhaps more accurately, when it does it works for special interests and not for the American people”.
The situation of the UK is perhaps even more fascinating, given that it faces an election this year – and is at more immediate risk of a ratings downgrade. The British government has the “advantage” (if one can call it that) that voters are long used to the concept of national decline, and relatively recent memories of fiscal belt-tightening.
But social cohesion and patriotism in the UK are fragmenting, and investors in gilts are apt to be far less patriotic than in Japan (not least because only 50 per cent of the gilt market is in domestic hands).
So will UK politicians be able to implement radical reforms with a spirit of shared sacrifice? Or will they do what Icelandic voters have done this week – and derail a government plan? And how will gilt investors react, as a country such as the UK starts fighting this out, or loses its triple A credit rating?
Right now, the answer is simply unknown. But the key point is this: if the past two years were a crucial test for global financial markets, the next two will be an equally critical test for the system of western government.
Stand by to see plenty more volatility and uncertainty in the government bond markets. The really big risk factors, be it in Iceland or the UK, the US or Ukraine, can no longer be easily factored into a spreadsheet.
gillian.tett@ft.com
Monday 4 January 2010
Re: Beware the crisis around the corner
Dear Mr. Crook,
Thanks for the article in today's Financial Times.
Your approach on rejecting categorically 'the restoration of Glass-Steagall act' and 'too big to fail' concept reminds me of the blind men and elephant story - from Indian fables - http://en.wikipedia.org/wiki/Blind_men_and_an_elephant
The real issue of the implementation can only be resolved when the issue of political funding is sorted. The real conflict of interest arises when the politicians who are elected to make decisions for the welfare of all are funded not by tax-payers money by the wall-street and other big businesses. Unless, this issue is tackled, you will see that even a dynamic elected leader like Barack Obama is nothing more than a 'domesticated representative of the vested interests'
Regards,
Pradeep Kabra
--------------------------
Beware the crisis around the corner
By Clive Crook
Published: January 3 2010 19:36 | Last updated: January 3 2010 19:36
The US economy is sickly, but the mood of impending doom has lifted. The response of US and other authorities to the emergency is unfinished business and needs continuing attention – but in 2010, if the crisis continues to ease, the danger is that politicians will relax and minds will wander from the need for new financial rules.
The next model of US financial regulation is unclear. The House of Representatives has passed a bill concentrating on regulatory structure: that is, on which regulators are responsible for what. What the Senate will do is anybody’s guess. Important as the regulatory organisation chart may be, however, it is not the key thing. The rules regulators apply are what matter.
The need for better rules is greater now than before the crisis. Critics of the US government say its response has made another financial collapse more likely – and they have a point. They worry about institutions that are too big to fail. The authorities encouraged consolidation as a way to restore short-term stability, but at what cost in the longer term? Attacking this concentration, critics say, is crucial.
One way to do this, they argue, is to restore the Glass-Steagall separation of commercial and investment banking. Create a heavily regulated, safe, utility-like system of deposit-taking banks and fence it off from the more lightly regulated casino of the securities markets. You would get institutions that are both smaller and more conservatively run.
It sounds plausible, but the debate over a new Glass-Steagall is unhelpful. The degree of interest in the idea is puzzling. After all, the financial collapse did not show that universal banks are more hazardous than separated commercial and investment banks. If anything, it showed the opposite.
Investment banks such as Bear Stearns and Lehman Brothers were thought to pose big systemic risks even though they were not deposit-takers. Moreover, the commercial banks that failed did so mainly through losses in traditional banking. So far as dealing in securities was concerned, the repeal of Glass-Steagall actually made little difference: the law permitted most of the securities transactions that commercial banks were undertaking when the crisis hit. Forget Glass-Steagall.
“Too big to fail”, on the other hand, is no distraction. It matters, and the reason why is familiar. A financial institution thought, or explicitly deemed by the authorities, to be too big to fail has a licence to take excessive risks. The problem is moral hazard. The implicit government guarantee will make its managers less cautious, and its creditors too. The burden of prudential oversight falls entirely on regulators, one they cannot hope to carry alone.
All this is correct – but it is not the whole, or even the larger part, of the problem. Remember that the US authorities, acting out of concern over moral hazard, let Lehman fail. In a way, they were right. It was not too big to fail: its collapse did not imperil the payments system and its counterparties did not fold. Yet praise for that principled decision was less than universal. Many argued, and continue to argue, that it was the worst mistake of the whole saga. The authorities are unlikely to forget this when another institution – which, regardless of its size, might be “too interconnected to fail” – looks ready to topple. And everybody knows it.
The precondition for big financial busts is always the same: unwarranted optimism. When everybody gets it into his head that inflation is tamed, interest rates will stay low, asset prices will keep rising and economic growth will never stop, overborrowing is sure to follow. In other words, moral hazard is only one factor reducing perceived risk. In a prolonged upswing, investors feel safe regardless – not because a bail-out will protect them from losses, but because they expect no losses.
Also, in that kind of climate people will tend to make the same mistakes. Many small banks making bad bets on property may be safer than a system with a few big ones doing the same thing – but only a little. The first small bank to fail might cause a crisis of confidence that would bring down others, and then the rest. After 2007-09, what government is going to risk finding out?
So judge the new rules by one criterion above all. In the words of a former Fed chairman, William McChesney Martin, do they take away the punch bowl before the party gets going?
Interest rates that take into account asset prices as well as general inflation are part of this, of course. But when it comes to financial regulation, the key thing is rules that recognise the credit cycle, and change as it proceeds. Most important, as argued by Charles Goodhart in these pages, capital and liquidity requirements should be time-varying and strongly anti-cyclical. In good times, when lending is expanding quickly and financial institutions’ concerns about capital and liquidity are at their least, the requirements should tighten. Under current rules, they do the opposite.
Fixing financial regulation is a hugely complex task, and the details matter. But no repair – whether it concentrates on ending “too big to fail”, on separating commercial and investment banking, or you name it – is going to succeed unless this simple principle is adopted. Financial institutions will oppose the idea, because it amounts to a tax on their growth. Of the many battles that one might fight in this area, this is one that simply has to be won.
clive.crook@gmail.com
Thanks for the article in today's Financial Times.
Your approach on rejecting categorically 'the restoration of Glass-Steagall act' and 'too big to fail' concept reminds me of the blind men and elephant story - from Indian fables - http://en.wikipedia.org/wiki/Blind_men_and_an_elephant
The real issue of the implementation can only be resolved when the issue of political funding is sorted. The real conflict of interest arises when the politicians who are elected to make decisions for the welfare of all are funded not by tax-payers money by the wall-street and other big businesses. Unless, this issue is tackled, you will see that even a dynamic elected leader like Barack Obama is nothing more than a 'domesticated representative of the vested interests'
Regards,
Pradeep Kabra
--------------------------
Beware the crisis around the corner
By Clive Crook
Published: January 3 2010 19:36 | Last updated: January 3 2010 19:36
The US economy is sickly, but the mood of impending doom has lifted. The response of US and other authorities to the emergency is unfinished business and needs continuing attention – but in 2010, if the crisis continues to ease, the danger is that politicians will relax and minds will wander from the need for new financial rules.
The next model of US financial regulation is unclear. The House of Representatives has passed a bill concentrating on regulatory structure: that is, on which regulators are responsible for what. What the Senate will do is anybody’s guess. Important as the regulatory organisation chart may be, however, it is not the key thing. The rules regulators apply are what matter.
The need for better rules is greater now than before the crisis. Critics of the US government say its response has made another financial collapse more likely – and they have a point. They worry about institutions that are too big to fail. The authorities encouraged consolidation as a way to restore short-term stability, but at what cost in the longer term? Attacking this concentration, critics say, is crucial.
One way to do this, they argue, is to restore the Glass-Steagall separation of commercial and investment banking. Create a heavily regulated, safe, utility-like system of deposit-taking banks and fence it off from the more lightly regulated casino of the securities markets. You would get institutions that are both smaller and more conservatively run.
It sounds plausible, but the debate over a new Glass-Steagall is unhelpful. The degree of interest in the idea is puzzling. After all, the financial collapse did not show that universal banks are more hazardous than separated commercial and investment banks. If anything, it showed the opposite.
Investment banks such as Bear Stearns and Lehman Brothers were thought to pose big systemic risks even though they were not deposit-takers. Moreover, the commercial banks that failed did so mainly through losses in traditional banking. So far as dealing in securities was concerned, the repeal of Glass-Steagall actually made little difference: the law permitted most of the securities transactions that commercial banks were undertaking when the crisis hit. Forget Glass-Steagall.
“Too big to fail”, on the other hand, is no distraction. It matters, and the reason why is familiar. A financial institution thought, or explicitly deemed by the authorities, to be too big to fail has a licence to take excessive risks. The problem is moral hazard. The implicit government guarantee will make its managers less cautious, and its creditors too. The burden of prudential oversight falls entirely on regulators, one they cannot hope to carry alone.
All this is correct – but it is not the whole, or even the larger part, of the problem. Remember that the US authorities, acting out of concern over moral hazard, let Lehman fail. In a way, they were right. It was not too big to fail: its collapse did not imperil the payments system and its counterparties did not fold. Yet praise for that principled decision was less than universal. Many argued, and continue to argue, that it was the worst mistake of the whole saga. The authorities are unlikely to forget this when another institution – which, regardless of its size, might be “too interconnected to fail” – looks ready to topple. And everybody knows it.
The precondition for big financial busts is always the same: unwarranted optimism. When everybody gets it into his head that inflation is tamed, interest rates will stay low, asset prices will keep rising and economic growth will never stop, overborrowing is sure to follow. In other words, moral hazard is only one factor reducing perceived risk. In a prolonged upswing, investors feel safe regardless – not because a bail-out will protect them from losses, but because they expect no losses.
Also, in that kind of climate people will tend to make the same mistakes. Many small banks making bad bets on property may be safer than a system with a few big ones doing the same thing – but only a little. The first small bank to fail might cause a crisis of confidence that would bring down others, and then the rest. After 2007-09, what government is going to risk finding out?
So judge the new rules by one criterion above all. In the words of a former Fed chairman, William McChesney Martin, do they take away the punch bowl before the party gets going?
Interest rates that take into account asset prices as well as general inflation are part of this, of course. But when it comes to financial regulation, the key thing is rules that recognise the credit cycle, and change as it proceeds. Most important, as argued by Charles Goodhart in these pages, capital and liquidity requirements should be time-varying and strongly anti-cyclical. In good times, when lending is expanding quickly and financial institutions’ concerns about capital and liquidity are at their least, the requirements should tighten. Under current rules, they do the opposite.
Fixing financial regulation is a hugely complex task, and the details matter. But no repair – whether it concentrates on ending “too big to fail”, on separating commercial and investment banking, or you name it – is going to succeed unless this simple principle is adopted. Financial institutions will oppose the idea, because it amounts to a tax on their growth. Of the many battles that one might fight in this area, this is one that simply has to be won.
clive.crook@gmail.com
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