Copper-Bottomed Investment

by ChrisCook Wed Dec 22nd, 2010 at 11:32:49 AM EST

I thought this post by AR Geezer deserved a Diary....

ARGeezer:

A Single Trader, JP Morgan, Holds 90% Of LME Copper  zero hedge

When a week ago we reported that JP Morgan has denied it owned more than 90% of the copper positions on the LME, we suggested that this could very well mean that Blythe Master's firm could just as easily control 89.999% of the copper and still not misrepresent the truth per that non-commital press release. Turns out our unbridled cynicism was spot on as usual. The Wall Street Journal has just reported that in the copper market "a single trader has reported it owns 80% to 90% of the copper sitting in London Metal Exchange warehouses, equal to about half of the world's exchange-registered copper stockpile and worth about $3 billion." Oh and yes, while JP Morgan technically is not singled out, we will be delighted to issue a retraction the second JP Morgan approaches us with a refutation that it is not the trader in question. And while we are at it, we also will repeat our claim that it was indeed JP Morgan that reduced its massive silver position, as per the recent FT article: as above we will immediately issue a retraction and apologize should JPM's legal department contact us that we are wrong on this. Somehow we don't think that will be an issue. And so it is once again made clear that the biggest market manipulating cartel in the world is not only JPM's commodity trading operation, but the "regulators" at the CFTC, who are doing all they can do to delay implementing rules on position limit- a stalling tactic whose sole purpose is to make the life of Jamie Dimon as comfortable as possible while he corners the copper market (and offloads his PM shorts to some "foreign bank"), even if that means the complete collapse in faith in the commodity market. Presumably, this means that Mr. Gensler has received an outsized Christmas gift to assuage his conscience. As for the commodity market, well, just look at what has happened to the stock market now that everyone knows it is nothing but a house of cards scam where a few robots front run each other. We are confident to quite confident tomorrow's ICI report will confirm that 33rd consecutive outflow from domestic equity funds. It is a pity that the same fate will now happen to the commodities market, as everyone tells Gensler to shove his corrupt market, and moves to physical. Frankly, it couldn't happen to a nicer group of so-called regulators.

Nice rant by Tyler. A few questions remain:

1. How much of the London Metal Exchange copper "owned" by JP Morgan is actually present at the LME? There have been rumors that the LMEs PM holdings, gold and silver particularly, have become "fractional reserve" holdings. But copper is more of an industrial metal and buyers usually take physical possession of large portions of what they buy.
   
2. Could this be like the tin corner of a few years back?
   
3. How much "paper copper" does JP Morgan hold and are they net long or short?
   
4. How many major banks would be impaired were the viability of JP Morgan as a counter-party come into question, especially with regards to derivatives?

The Myth of 'Tax and Spend'

by ChrisCook Thu Dec 16th, 2010 at 06:17:17 AM EST

I posted a comment in response to a 'Think Piece' by Terry Arthur on the Adam Smith Institute site who is basically going down the Austerian road of 'Public expenditure destroys jobs" which the likes of Peter Schiff bring to a fine art.

In my view virtually all schools of Economics have - either mistakenly or for ideological reasons - the polarity of money reversed. It is a credit instrument, not a debt instrument.

So in a nutshell my argument is that in the same way that credit creation precedes deposits (rather than vice versa) it's not a question of 'Tax and Spend': the reality is 'Spend and Tax'.

Anyone pick holes in that?

LQD: Bear-faced robbery?

by ChrisCook Thu Apr 24th, 2008 at 09:20:14 AM EST

There's an interesting story circulating in relation to the final days of Bear Stearns

Bear Raid

The source is a blog run by an options expert by the name of John Olagues.

The allegation is that someone bought massive amounts of deep "out of the money" Bear Stearns "Put" stock options in the run up to the collapse.

What this means is that they acquired the right to sell Bear Stearns stock at a price far below the then current price of $70.00 per share.

In this case at $17.50 at $15.00 and even at $10.00.  

If the price remained above this figure by the time the option expired, the buyers of the "Put" would have lost the premiums they paid. But as we know now, it didn't, and actually collapsed to $2.00.

In order to do this, they had to ask the relevant exchange to open new "series" of option "strike prices"  at price levels way below anything in existence, I think.

There is nothing unusual for an option exchange to do that - particularly for dates well into the future - but the thing about this alleged market coup/ trading scam is that the expiry date for the requested series were relatively close by, in April, and evn March - which had only days to run.

As the article explains, this fact means that the "time value" of the options was therefore minimal, and the leverage vastly increased.

Essentially these people were betting on an "outsider" they knew was going to win....

The introduction of those far-out-of-the-money put series in the April and March months immediately before the crash provided a vehicle whereby extreme leverage was available to the insiders.

In other words if an insider had $100,000 and he knew that Morgan would buy Bear Stearns at 2, he could make 5-10 times more on the $100,000 by buying the newly introduced March puts. This is so because the soon to
expire far out-of-the-money puts were far cheaper than the July or October out-of-the-money puts.

And that is why the illegal inside traders requested the exchanges to introduce the far out-of-the-moneys just days before the crash.

As a former regulator myself, I would be crawling all over these trades.

The sheer greed and blatancy of this - if it is what happened - is absolutely staggering.

One question that occurs to me is who actually sold these Put Options? And why aren't they creating merry hell about the losses?

Where is Spitzer when we need him?

Peak Credit - my Op Ed in Asia Times

by ChrisCook Thu Apr 10th, 2008 at 03:32:03 AM EST

Well, "Asia Times Online" have just published my article

Peak Credit and a Flight to Simplicity

and for those of you who are dazzled by the flashing ads on that site the text follows.

Peak Oil - the theory that we may be at or near a peak level of oil production - while remaining controversial is at least now respectable. But is the continuing credit crash masking another inconvenient truth? Might banks now be experiencing the aftermath of peak credit?

What is a bank anyway? They are actually credit institutions. They create the credit - as interest-bearing loans - which constitutes the life blood of the economy. This credit actually is the bulk (or more than 97%) of the money in use in the US, the rest being notes and coin.

Banks stand between borrowers and depositors: they extend credit to borrowers and receive credit from depositors. So they are also middlemen or credit intermediaries.

Promoted by Migeru

Peak Credit

by ChrisCook Fri Mar 28th, 2008 at 06:12:32 AM EST

I had this article published today in the compliance industry resource site Complinet

I'm using the material as source for a series of articles aimed at newspapers.

The Future of Compliance: Part One - Peak Credit

Mar 28 2008

Surveying the aftermath of JPMorgan's dramatic acquisition of Bear Stearns and the impotence of the Federal Reserve's "conventional" monetary solutions, it is clear that dramatic, and unprecedented, events are unfolding. Since this is a dynamic process, any commentary is subject to be contradicted within 24 hours, resurrected as conventional wisdom in a week, and dispatched to the outer darkness of history within a month. Whatever the outcome, however, some of the regulatory issues have been evident for some time and others are now emerging.

This article is the first of two concerned with the effect of current developments upon the world of compliance. Despite the kind of special pleading currently seen from the likes of Alan Greenspan, the former chairman of the US Federal Reserve, the effects of this regulatory disaster can only be a call for a retreat from the process of deregulation many commentators regard as responsible.

To predict where the compliance industry goes from here it is necessary to outline the events and trends which constitute almost tectonic movements in the financial markets. To do so, compliance is approached as an essential form of market "quality control".

Peak credit?

The subject of "peak oil" is usually misrepresented to mean "oil is running out" but in fact means that, "while there may be plenty of oil in the ground, there is a maximum (peak) level of production which we may even have reached". Peak oil has gradually evolved from a wild "crank" theory to the relative respectability of -- a well-known phrase -- an "inconvenient truth".

The consequences of peak oil are not within the scope of this article but serve as an analogy for another phenomenon -- peak credit, which, like peak oil, may in fact already have occurred.

Banking

A bank is a credit institution with a monopoly privilege to create credit backed by an amount of regulatory capital set by the Bank for International Settlements (Basel Accords I and II). The interest-bearing loans or credit which banks create is actually the money we use, and this keeps the economic world turning on its axis. Credit institutions create this money which is then instantaneously re-deposited back into the banking system. Without this flow of new credit there would be no development and no economic growth.

It should be noted at this point that most people -- even the most financially sophisticated -- are under the misapprehension that what banks do is to first take in deposits (i.e., pre-existing money) and then, second, loan them out again. This is actually what credit unions do and what "licensed deposit takers" (prior to the Financial Services Act) used to do. The fact is, however, that credit institutions (aka banks) actually create loans first as new money which become deposits second. There is intense competition among banks to gather in these deposits at an advantageous rate of interest.

Credit intermediation

There are two types of credit:

    * "Trade" credit -- extended by a seller to a buyer and familiar to anyone involved in bilateral over-the-counter markets.

    * "Bank" credit -- extended by a bank to a borrower and by a depositor to a bank.

The economic role of a bank is to stand between or "intermediate":

    * Borrower -- someone who is receiving something of value from the bank and promising to provide something of value in the future; and

    * Lender -- someone who is giving something of value in exchange for a promise from the bank to provide something of value in the future.

If we deconstruct this relationship we see that the bank is guaranteeing the credit of the borrower. The charge the bank makes for doing so (interest) must cover interest paid to depositors, the bank's operating costs and the costs of defaults, and will hopefully thereby provide an additional margin as profit.

In other words, the credit itself does not cost anything to create. It is the guarantee function that is the economic value provided by the bank and this implicit guarantee is supported by the pool of "regulatory capital".

Asset-based and deficit-based finance

As credit involves a "promise to pay" and as "debt" constitutes one of the "twin peaks" of financial capital, credit may be thought of as "deficit-based" finance. The other peak is "equity", which involves actual "ownership" of productive assets in legal vehicles.

Historically, this has been the "joint stock limited liability company" or "corporation"; however, there are an increasing number of alternative vehicles such as trust and partnership-based vehicles, which together may be thought of as "asset-based" finance. The problem is that the bulk of financing of productive assets globally has been a hybrid,

i.e., for the most part, it consists of credit that credit institutions have created and secured by a legal claim over productive assets that the borrower owns.

Deficit-based finance that is "property-backed", i.e., mortgage loans, underpins in excess of two thirds of the money which the Federal Reserve Bank and the Bank of England issues.

Asset bubbles

The first credit-fuelled "bubble" was the one that the remarkable Scot, John Law, instigated in France, when he created the first example of a central bank in recognisably modern form in 1718 -- the Banque Royale -- and used it to fuel a massive speculative bubble in the share price of the French Mississippi Company (Compagnie des Indes).

Since then, a never-ending series of financial bubbles has been a recurring phenomenon in the financial markets and all bubbles have involved the excessive use of deficit-based finance by investors to buy productive assets.

The result is that asset prices lose touch with the reality of the underlying revenue flows that the assets have generated. Inevitably, the asset price reaches a level at which no further borrowing is possible and the asset price collapses, taking the borrower, and often, the banks which deficit financed the bubble with it.

The pyramid of cheap dollar-denominated credit built in recent years upon US land rental values is such that the current process of "de-leveraging", which has only just begun, is, at worst, in danger of sucking the US into a depression or, at best, a Japanese-style economic stasis.

Some would argue that the credit level created in the US reached an unsustainable peak some months ago and that a fundamental restructuring -- a Bretton Woods II -- is now necessary.

The role of banking innovation

The main issues have been the emergence of new financial techniques, and the re-emergence of old ones, and the regulatory response to these. In recent years banks have been increasingly able to "outsource" to investors the risks of their implicit guarantee. This risk transfer has occurred in three principal ways:

    * Securitisation -- permanent transfer.

    * Credit derivatives -- temporary transfer for a defined period.

    * Credit insurance -- partial transfer.

There has also been a massive growth of complex structured products that involve the "dicing and slicing" of risk.

The regulatory risks inherent in securitisation are not new. These were the principal reasons for the separation by the Glass-Steagall Acts in 1933 of investment banking and commercial banking in the aftermath of the US stock market bubble which led to the 1929 Wall Street Crash.

There have already been calls for the reinstatement of this separation and these calls are likely to grow stronger both as the current crisis unfolds and as lessons are digested in the aftermath, whenever that begins.

Clearly, there will be a reappraisal of the other risk transfer mechanisms as well. In particular, the capitalisation of "monolines" and the risks they undertake in ensuring credit risk will be the subject of intense regulatory scrutiny.

Credit derivatives have proved too useful a tool to be destined for oblivion, unlike most of the financial "toxic waste" now gravitating towards the Fed silo. There may be an increased emphasis on transparency, however, and a drive towards standardisation of terms.

Rating agencies

The role of rating agencies and, in particular, the commercial conflicts of interest between the shareholder owners of such agencies and some of the market participants who rely on their neutrality, has already come in for considerable debate and discussion.

This debate is expected to continue and the relationship between regulators and agencies will be reviewed. One radical approach might be to encourage the evolution of a new generation of rating agencies that operate on a not-for-profit basis.

Asset-based finance and 'unitisation'

New asset-based financial tools are continually evolving. For example, the emergence of "income trusts" and "royalty trusts" in Canada has created an entirely new asset class of "units", which comprise rights to part of the gross revenues of listed corporations that have been attractive to long-term investors, such as pension funds who see an advantage in accessing corporate revenues before the management does.

The recent Blackstone IPO was not dissimilar, in that it was not a sale of conventional shares but a sale of partnership interests in Blackstone revenues.

Other growing forms of asset-based finance are: exchange-traded funds; real estate investment funds; and Islamic finance, which is inherently asset-based albeit some of the current generation of "sukuk" vehicles do not necessarily share risk and reward in a way that most Muslims would consider ethical.

Asset-based finance may also be used as a replacement for the increasingly scarce availability of deficit-based, but asset-backed finance. This will continue to be the case at least until banks' balance sheets have been repaired, which -- as we have seen in Japan -- may be a very lengthy process, and moreover, a process that cannot even begin until the market has stabilised.

Governments and guarantees

The contrasting approaches of the US regulatory system, which the Fed drives, and the fragmented "tripartite" (HM Treasury, Bank of England and the Financial Services Authority) approach in the UK have been brought home by the marked difference in the protracted Northern Rock saga and the blitzkrieg approach of the Fed to Bear Stearns.

Decisiveness is all very well of course but the political ramifications, in particular, the democratic accountability and transparency of both the Northern Rock and Bear Stearns "rescues", require careful study.

It is possible to imagine a new approach to the roles and responsibilities of national financial regulators, treasuries, monetary authorities and central banks. Indeed, it is even possible to question the necessity of a central bank at all -- Hong Kong, for instance, has never had one.

The challenge of napsterisation

The next article will consider the continuing and profound changes which flow from the pervasive spread of the internet and, in particular, the effect that the arrival of peer-to-peer direct connectivity ("napsterisation") is already having on the legal and financial structure of markets.

Markets are becoming globally networked; however, regulation remains firmly bound to disparate national jurisdictions. Regulation that is appropriate for intermediaries is entirely redundant for the regulation of "end user" market participants on the one hand and the emerging breed of market service providers on the other.

It is here, in the current transition from "transaction-based" markets that involve intermediaries in a new generation of globally networked markets based upon new forms of service provision, that new opportunities and challenges lie and the compliance industry will be at the heart of this transformation.

LYT Diary: the Future of Property Sales

by ChrisCook Sat Mar 8th, 2008 at 07:36:04 AM EST

Some Norwegians have posted on youtube this

entirely idiosyncratic "rap" on the merits of their flat in Oslo.  

It's in Norwegian of course, but that isn't really the point!

I hardly think Norwegian estate agents (which barely existed 20 years ago) are quivering in their boots - but it does open up some new ideas for a "Property Channel".

Get on it, Sven!

Light entertainment for a lazy Saturday afternoon - Diary rescue by Migeru

Saudi broking US/Iran rapprochement?

by ChrisCook Tue Mar 4th, 2008 at 05:12:29 PM EST

This article is in an Israeli niche publication, and in view of its cool neutrality, doubly credible

Ahmadinejad in Baghdad

The article adds credence to the view

Yet in Tehran, DEBKAfile's Iranian sources report, the president's excursion into US-occupied territory was counted as a step forward in its seven-month old secret Saudi-mediated dialogue with Washington.

This dialogue has advanced in give-and-take steps on a broad set of issues.

that - as has been obvious for some time - the US and Iran started to develop some sort of accommodation around August of last year.

The most prominent is Iran's nuclear program. The third round of UN Security Council sanctions imposed Monday, March 3, banning trade with Iran did not really bother Tehran. The penalties were predicted and anticipated. Iran's rulers can live with a motion which they see as the Bush administration's parting shot in the dispute over the uranium enrichment issue. Not surprisingly Israel was not satisfied.

But mostly they are looking ahead to the next US president and their objective is clear: the cementing of the incumbent White House position on the North Korean nuclear weapons status as a convention which its next tenant will apply to Iran. This in rough terms means accepting a Tehran guarantee to freeze its uranium enrichment process, its nuclear bomb program and nuclear-capable ballistic missile project, without demanding their dismantlement.

This outline would be deemed in Tehran a positive basis for a nuclear deal with Washington.

Coming from an Israeli publication, there is, unsurprisingly, an assumption that there is a nuclear bomb program. My own view (based upon personal experience of the void between rhetoric and reality in Iran) is that if that is the case, it is not in fact deliverable in under 10 years at a minimum, and longer under a meaningful sanction regime.  

What does the Bush administration expect from Tehran?

According to our Washington sources, George W. Bush is keen to hand his successor a relatively stable Iraq where the violence spiral sustains its downward curve. The US president accordingly stopped direct US military action against pro-Iranian Shiite "special groups," in the expectation that Tehran will use its influence to keep Iraq on a relatively even keel for the remainder of his term in office.

The quid pro quo runs like this: Tehran is bidding for an understanding with Washington on its nuclear program, while the US is after Iran's help to preserve the status quo in Iraq.

Iran has two powerful resources for delivering the goods:

1. An extensive clandestine intelligence and military infrastructure across Iraq that will obey Tehran's orders to pull in its horns.
   
2. Tehran's hand on the spigot of the flow of weapons, money and extra-powerful roadside bombs to the different anti-US insurgent groups.
   

 

This seems to be the most objective bullshit -free assessment I have seen in a long time with a strong ring of truth.

And now to the nitty gritty: oil.

The third key issue dominating the US-Iranian dialogue is southern Iraq and its oil. This is also pivotal for Iran's bilateral relations with Iraq.

Ahmadinejad's hosts in Baghdad have to live with the realization that their guest has more clout with the Shiites of southern Iraq than the Maliki government.

Tehran's dominance of southern Iraq has three focii:
The shrine-cities of Karbala and Najef and the oil port of Basra. Iran and the radical Iraqi Shiite cleric Moqtada Sadr at the head of his Mehdi Army militia divide control of these three cities between them.

If the central government wants any say in southern Iraq, it must stay on good terms with both its rival masters.

Again, that seems a pretty credible assessment to me of the realities on the ground in Southern Iraq.

During his last visit to Tehran at the end of last year, prime minister al-Maliki signed an agreement to lay a pipeline taking Iraqi oil to Iranian refineries in Abadan.

This was a bid to link southern Iraq's oil to the Iranian oil fields and installations on the eastern bank of the Shatt al-Arb opposite Basra.

The Americans, who control and defend the southern oil fields, let the agreement go through, although they are in competition against Iran in Central Asia and Turkey. The Bush administration is reconciled to including southern Iraq and its oil fields in the overall package of Iraq understandings with Tehran.

Despite the "Iranian hegemony" propaganda, the US knows that Iran has never had any territorial ambitions (other than the odd maritime border dispute) over Iraq - merely a desire for security guarantees.

I would be interested to know exactly what form of goods and services will be provided to Iraq by Iran under the $1bn credit announced during the Baghdad visit. I would be surprised if oil equipment weren't part of it.

It's a long way from being over, but if August last year saw the End of the Beginning in Iraq, this visit by Ahmadinejad might be the Beginning of the End.

And is it the Saudi's wot done it?

That would be entirely consistent with my own experience with the Middle East Exchange (morphed to the infamous "Iran Oil Bourse") I initiated in mid 2001, which was apparently vetoed by the Saudi's, only for them to withdraw the veto a couple of years post 9/11 when the US/ Saudi relationship became more "arm's length".

The fact is that the Saudi's OPEC dominance means that the Iranians have always listened closely to what they have to say.

Anglo Disease - and Adam Smith

by ChrisCook Sun Mar 2nd, 2008 at 01:21:08 PM EST

Apparently there's a new book on the way about Adam Smith by PJ O'Rourke, who is in Edinburgh to promote it.

So we had this extract in the Sunday Herald today.

I for one have never ploughed through anything by Smith, or come to that any of the "greats", and am therefore reliant upon the perspective, values, accuracy and good faith of those commentators who have.

O' Rourke's book looks promising, I must say, if the extract in the Herald is anything to go by.

A few gems follow: firstly, for our US friends...

Some acolytes of Smith might be surprised if they ever read him. He wrote that "the oppression of the poor must establish the monopoly of the rich", and that profit is "always highest in the countries which are going fastest to ruin".

For those persuaded of the need for a tax on land values, the following might indicate support from Smith....

Adam Smith was tough on the landed gentry: "As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed."

He would have been amused to see the dukes and duchesses of England reduced to keeping circus animals and other attractions on their great estates and letting fat daytrippers waddle through their stately homes, camcording the noble ancestors on the walls.

But it was this nugget that persuaded me that Adam Smith would have been well at home in ET's occasional Anglo Disease series....

Smith was tougher yet on the very people who, in his time, were beginning to generate the wealth of nations that he proposed to increase. Despite his friendship with merchants and manufacturers in Edinburgh and Glasgow, Smith had a cool loathing for the class: "Masters are always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labour.

"Our merchants and master-manufacturers complain much of the bad effects of high wages in raising the price of their goods both at home and abroad. They say nothing concerning the bad effects of high profits.

They are silent and regard to the pernicious effects of their own gains. They complain only of those of other people.

And as for the privatisation mania, Smith had no time for the East India Company's depredations in India...

And Smith was no enthusiast for the privatisation of government functions. Concerning the East India Company and its rule of Bengal, Smith wrote: "The government of an exclusive company of merchants is, perhaps, the worst of all governments for any country whatever."

Finally, and fairly crucially, was Smith's distinction between (acceptable - indeed necessary, in his view)"profits" and "pernicious gains".

Smith wanted "the establishment of a government which afforded to industry the only encouragement which it requires, some tolerable security that it shall enjoy the fruits of its own labour". Smith did not consider profits to be the same as "pernicious gains".

Now my own distinction between "acceptable"  and "pernicious" profits is that between those profits achieved by the producer, and those by the "rentier".

The reason I am hopeful that there is a way out of the deep hole the financial system is in, is that there are new forms of finance capital now emerging to replace the "pernicious" tools of finance capital - ie Debt and "Equity" - which are IMHO the direct causes (with private property in Commons) of the Anglo Disease.

LYT Diary:The Great Tax Clawback Scam

by ChrisCook Sat Mar 1st, 2008 at 05:22:03 AM EST

This is the first LYT (Lazy Youtube) Diary.

Fred Harrison is a leading, and eloquent, "Georgist" - that is to say a proponent of the ideas of one of the greatest political economists of the 19th Century - Henry George.

His seminal work Progress and Poverty made him the second best known person in the US after the President but George has essentially been "airbrushed" from History by the proponents of conventional political economy and their domination of discourse in both academia and media.

George proposed a "Single Tax"  - a tax on the privilege of exclusive "ownership" of the Commons of land - and in this video Harrison outlines the rationale for a re-basing of taxation away from income, towards "wealth" through the use of this mechanism.

I do not believe that many people can actually deny the equity (although they may certainly resist the application in their own case!) of the principle that those who have exclusive private use of "Commons", such as Land (Real Property) and Knowledge (Intellectual property) should compensate those they exclude.

Strangely enough, this concept is non-ideological, having in its time been attacked from the Left and the Right, both on the basis of their own assumptions.

The heyday of the idea was at the turn of the 20th Century when the Liberals under Lloyd George enacted it only for that Act to be overturned by the House of Lords.

That pivotal constitutional battle in turn led to the emasculation of the House of Lords, but not soon enough to revive the concept after the chaos of the First World War and the political upheavals which followed it.

The logic of Harrison's case for Land Value Tax is IMHO unassailable, and indeed the guru of the neoCons himself - Friedman - regarded it as the "least worst" tax. Moreover, the concept is regarded with favour by commentators including Sam Brittan and Martin Wolf of the FT, and constitutes one of my few areas of total agreement with the latter.

For my part, I think it will be possible to implement the principles of the tax in another way through a new approach to property rights possible through the application of a new legal and financial structure or "enterprise model" to land.

Bank of England & Northern Rock

by ChrisCook Tue Feb 12th, 2008 at 07:26:41 AM EST

One or two friends and colleagues of mine with an interest in monetary matters have been in correspondence with the Bank of England re Northern Rock.

I wrote to the Governor of the Bank of England asking about where the Bank's money for Northern Rock came from, and was it created out of nothing.  

The reply ....(from an acolyte)....  claims the money comes from " 'reserve balances which is money held by the banking system in accounts at the Bank....".

Note that these reserve balances are essentially interest-free loans by the clearing banks to the Bank of England.

There was then this startling admission

"These balances are a form of 'central bank money' and the Bank has taken steps to offset the creation of central bank money by lending less in its regular market operations than it would otherwise have done."

that the banking system is being starved of liquidity as a result of the (hugely profitable) harvesting by the Bank of England of "seignorage" in respect of its loans to Northern Rock. These profits arise out of the fact that the Bank of England is lending to Northern Rock at base rate (plus an accumulating penalty payable in due course to the Treasury) money which it is funding at zero cost.

ie as pointed out twice in the FT by Tim Congdon, and documented here, the truth of the matter is that the more that is lent to Northern Rock in this way, and the longer these loans go on, the more money the long-suffering "tax payer" will actually make through the resulting Bank of England profits, provided there are no defaults.

Bu what if there were defaults?

So, all in all, there is an admission that the money was created by the Bank and the fun really will come if the money gets lost by Northern Rock because I happen to know that somebody has written to the Bank asking how that loss would be written in the Bank's accounts..........Watch this space....---

Again, we have discussed in ET at some length the effect upon the system and the poor bloody taxpayer of a default by the Northern Rock in its loans from the Bank of England.

My view is that the taxpayer would suffer no loss at all, and that the actual monetary effect of such write offs would be zero.

Now, on to a slightly different question , relating to the effect of government borrowing in itself.

....in response to another question the acolyte says that Article 101 of the Maastricht Treaty makes it illegal for central banks to provide loans to governments.

Er hem -- except when it's Northern Rock, of course.

But I asked about lending to the government in the context of loans to governments for public capital projects (thereby halving or more the cost of the projects).  So you can see how the banking system has worked to stitch up everything so that all lending is always done at interest -- even lending for hospitals.

And, of course,  the acolyte, said that lending to a government "could be inflationary".

Which brings us to the key fallacy at the heart of our monetary system, which is the official - unassailable and undiscussable - position that the creation of money - ex nihilo - by private bank lending at interest is by definition less inflationary than the creation of money ex nihilo by Central Banks without an interest burden.

In my view, Central Banks and all other banks are - like all other intermediaries in the age of the Internet - no longer necessary.

The point is that credit in itself costs nothing to create: the real value provided by the banking system lies in the guarantee provided (and backed in the case of private banks by an amount of "regulatory capital").

Unfortunately, this guarantee function has essentially been opaquely "outsourced" by the banking system either totally (securitisation); partially (credit insurance) or temporarily (credit derivatives) with the result being the ongoing "Credit Crash" which is in its first (driver hitting the windscreen) phase.

I believe that it is essential, and actually, quite straightforward, to reconfigure the credit markets to establish an alternative disintermediated mutualised structure.

LQD: Northern Wreck

by ChrisCook Wed Jan 23rd, 2008 at 03:07:11 AM EST

An interesting snippet from a banking guru on the Gang8 Yahoo list.

I don't have the Financial Statistics Table 4.2A he refers to, and probably would have difficulty interpreting it if I did!

How daft can Central Banks get?

I attach the latest table 4.2A from the Financial Statistics. It shows the Bank of England balance sheet post the loan to Northern Rock.

You will see that the Bank has financed the loan to a very large extent by cutting back on Open Market Lending. In other words it has stripped the rest of the banking system's liquidity to the extent of the advance to Northern Rock, and as a result the latter cannot be repaid!

For the love of Mammon! - promoted by Migeru

LQD: Anglo Disease: Another Symptom?

by ChrisCook Sat Jan 19th, 2008 at 11:58:09 AM EST

It's probably been remarked upon here before and I missed it but a recent article Lenders to rely on Funding Models tells us that despite the Northern Rock fiasco lenders are going to continue to rely on wholesale funding.

My question is: do they have any choice?

Or is another symptom of the Anglo Disease the fact that the retail depositor is a dying breed, and that the people in whose hands wealth is concentrating don't tend to have a deposit account with the Chipping Sodbury Building Society?

I find this an interesting and depressing comparison.

The group said UK lenders had traditionally used savings deposits to fund their mortgage business, but raising money through the wholesale markets had become increasingly popular in recent years.

It said during 2000 wholesale markets accounted for an average of just 27.8% of all funding, but by the first half of 2007 this had nearly doubled to 47.8%.

Scratch my head as I might, I really cannot see any way - in the current paradigm - how this trend could be reversed.....

Northern Rock around the Clock

by ChrisCook Fri Jan 18th, 2008 at 07:22:00 PM EST

Government bails out Shareholders?

Robert Peston, the BBC business editor has always had the Inside Track on Northern Rock, so that we see after a week of dithering Gordon has finally decided to bail out the shareholders.

Or rather, that's what it looks like at first blush.

Prime Minister Gordon Brown has backed a plan from bankers Goldman Sachs to convert the Bank of England's loans to Northern Rock into bonds for sale.

These bonds would stay on the public sector balance sheet until conditions improve in financial markets.

They would then be sold to investors in small parcels every few months.

The sales would take place as and when financial institutions regain their appetite for such investments.

And they would be guaranteed by the government, rather than by a private sector insurer.

They would use a special purpose vehicle as a "wrapper" for this "securitisation"

Under the Goldman Sachs plan, the Rock's assets would be put into a special purpose vehicle.

This special purpose vehicle would then sell bonds over the coming months and years, as markets recover.

The key questions are:

(a) what rate will these bonds be paying?

(Since this constitutes a major part of Northern Rock's funding costs, and directly affects their profit); and

(b) what will the Government get for their guarantee?

(Again, a cost affecting shareholders)

As Peston says

On those terms, it will be difficult for Northern Rock not to agree a deal with either the Virgin consortium or Olivant - the private sector groups vying for control of Northern Rock.

But what about the "tax-payer"?

Taxpayer exposure

In theory, this would gradually reduce the taxpayers' exposure to the Rock.

A substantial taxpayer exposure, of tens of billions of pounds - in the form of direct loans and guarantees to other lenders and depositors - could remain in place for years. However the Rock would be expected to pay a fee to the government in return for this substantial support

Well: maybe.

We have discussed in detail on ET exactly what effect on the poor bloody taxpayer a default would have. Personally I believe that what the taxpayer has never had, the taxpayer would never miss.

ie the effect would be the same as burning a few skip loads of time-expired bank-notes.

However, some on ET believe the effect would be inflationary.

I don't see how defaults (which essentially destroy money) can be inflationary.

The government may well be attacked by opposition parties for subsidising what could turn out to be vast profits for any future private sector controller of the Rock, such as Sir Richard Branson's Virgin Group.

Dead right. This is potentially the original "licence to print money".

Whatever the effect on inflation, this is a potential goldmine for Branson's Virgin or Olivant. And if it isn't, they simply won't do it.

There must be another way.

The point ignored in all this (in fact, almost deliberately concealed) is that Bank of England credit costs nothing to create, and the "seignorage" on the money minted by the Bank of England to loan to Northern Wreck has been rolling in at the rate of £25m a week plus. These seignorage profits actually will in due course accrue to the tax-payer, as they do now in respect of banknotes in circulation.

The real value provided by Banks aka Credit Institutions (beyond clearing system administration) is that of a guarantee, and they back this guarantee with a pool of Capital as required by the Bank of International Settlements.

The Bank of England, on the other hand, backs their guarantee with nothing at all other than trust and faith.

A Northern Rock Partnership?
No prizes for guessing what I think should be done instead. In my view, a fee should be paid by Northern Rock to the Government for the use of the guarantee into a "Default Pool", and this accumulating fee should form Equity ranking alongside that of the existing shareholders.

This could be accomplished by putting the assets into the hands of a Trustee/Custodian - where most assets are already (quite unknown to the beneficiary of the Trust - the Northern Down's Syndrome Association!), via the opaque "Granite" SIV.

An LLP could be used as a framework / Special Purpose Vehicle for what would be a revenue sharing "Capital Partnership" between Investors and Managers instantly recognisable to Islamic investors.

In this way:

(a) the risks and rewards could be shared equitably, which I would bet my bottom dollar they will not be in the bailout as proposed by Goldman;

(b) there could be a single asset class consisting of proportional "units" or "nth's" in Northern Rock's net revenues after a provision is made into the Pool.

It will be interesting to see what the Northern Rock share price does on Monday.....

LQD: Spending or Saving?

by ChrisCook Wed Jan 9th, 2008 at 12:22:49 PM EST

Stephen Roach - Chairman of Morgan Stanley Asia - was in the FT yesterday saying that
America's inflated asset prices have to fall

This was well deconstructed by Professor Michael Hudson in the gang8 list in which I am a member. Unlike me he is a polymath well able to defend his corner academically, and he also happens to be Kucinich's economic adviser.

The following may therefore be of interest to ET'ers....

Roach: The US has been the main culprit behind the destabilising global imbalances of recent years. America's massive current account deficit absorbs about 75 per cent of the world's surplus saving.

Hudson: This is nonsense. The U.S. balance-of-trade deficit and U.S. foreign investment pump dollars into foreign exporters and sellers of raw materials. The exporters and other dollar recipients turn over these dollars to their central banks for domestic currency or other non-dollar currencies. The central banks then end up with these dollars  and until recently they have invested them in U.S. Treasury bills, although they are now looking to buy "hard assets" (mineral resources in Africa, companies in Asia) as they see that the United States has no ability  much less, willingness  to pay these U.S. Treasury debts.

U.S. consumers spending abroad is NOT saving. The money that comes back is a dollar glut, NOT foreign "income less consumption". Balance-of-payments accounting thus confuses the usual quack-macroeconomic national income observers.

Most believe that a weaker US dollar is the best cure for these imbalances. Yet a broad measure of the US dollar has dropped 23 per cent since February 2002 in real terms, with only minimal impact on America's gaping external imbalance.

Roach: Dollar bears argue that more currency depreciation is needed. Protectionists insist that China - which has the largest bilateral trade imbalance with the US - should bear a disproportionate share of the next downleg in the US dollar. There is good reason to doubt this view. America's current account deficit is due more to bubbles in asset prices than to a misaligned dollar. A resolution will require more of a correction in asset prices than a further depreciation of the dollar. At the core of the problem is one of the most insidious characteristics of an asset-dependent economy - a chronic shortfall in domestic saving.

Hudson: Here again, the Big Lie of the financial sector's con game. There is NO shortfall in domestic US saving. Gross saving is as high as ever. But only the wealthiest 10 percent are doing it  and are lending it out to the bottom 90%. When savings are lent out as debt, the result is a wash. This is NOT the case when savings are invested in tangible new means of production. That represents a build-up of equity. But that is not occurring today.

So the real problem is that saving is taking the form of loans,not equity investment. This is precisely what the St. Simonians explained in France from the 1820s through 1860s. And for that matter, what Islam pointed to a millennium earlier.

(And, for that matter, what I am pointing out now, except that I advocate the extension of Equity to include new forms of investment in land, property and renewables among other things: ChrisCook)

The solution, according to financial lobby Stephen Roach (Chairman of Morgan Stanley Asia), is more tax breaks for the ultra-rich who do the saving. The problem is that they also do the indebting. Their credit finds its counterpart in the rest of the economy's debt. It takes the form of corporate stock buybacks, junk bonds issued by corporate raiders or for M&A activity, junk mortgages, and increasingly, junk credit-card debt now that defaults and bankruptcies are beginning to soar. (Today, AT&T announced lower earnings as phones are being turned off all over the United States for non-payment.)

Roach: With America's net national saving averaging a mere 1.4 per cent of national income over the past five years, the US has had to import surplus saving from abroad to keep growing. That means it must run massive current account and trade deficits to attract the foreign capital.

Hudson: Another confusion. It is the trade deficit that produces the savings that foreign central banks recycle back to the US. Roach confuses the direction of causality.

Roach: America's aversion toward saving did not appear out of thin air. Waves of asset appreciation - first equities and, more recently, residential property - convinced citizens that a new era was at hand. Reinforced by a monstrous bubble of cheap credit, there was little perceived need to save the old-fashioned way - out of income. Assets became the preferred vehicle of choice.

Hudson: Yet another misrepresentation. New homebuyers faced a choice: miss out on home ownership and continue renting  at rising prices  or take on a lifetime of debt. Tax cuts for property have left a larger land rental value to be capitalized into yet larger loans.

So the financial sector's campaign for property-tax cuts have fuelled the mortgage bubble, coupled with Alan Greenspan's flooding the economy with enough money to drive down interest rates, lengthen maturities to zero-amortization loans, make zero-down-payment loans, "liar" loans with no confirmation of income, and repeal of federal regulation over bank mortgage lending. Mr. Roach's company made billions of dollars packaging junk mortgages. And now he demands more tax cuts for "savers" - his financial sector clients.

Roach:With one bubble begetting another, America's imbalances rose to epic proportions. Despite generally subpar income generation, private consumption soared to a record 72 per cent of real gross domestic product in 2007. Household debt hit a record 133 per cent of disposable personal income. And income-based measures of personal saving moved back into negative territory in late 2007.

None of these trends is sustainable. It is only a question of when they give way and what it takes to spark a long overdue rebalancing. A sharp decline in asset prices is necessary to rebalance the US economy. It is the only realistic hope to shift the mix of saving away from asset appreciation back to that supported by income generation. That could entail as much as a 20-30 per cent decline in overall US housing prices and a related deflating of the bubble of cheap and easy credit.

Hudson: This is what I call debt deflation: Debt service diverts income away from spending on goods and services.

Boxing Day punch up material

by ChrisCook Wed Dec 26th, 2007 at 11:12:15 AM EST

I was bemused by the vehemence of debate which took off in the "Hostility to the Limits of Growth" thread once Deepak Chopra made an appearance.

On the one hand we have the rational scientists, and on the other those who believe science may be extended into the realm of spirituality.

<And that's without even mentioning "Art"!>

I'm going to chuck two things into the Pot. Firstly a very lazy quote from a blog concerning Robert Pirsig's
Metaphysics of Quality

The Metaphysics of Quality (MoQ) is an intellectual ordering of experience; it is a way of organising our knowledge; it is a filing system for the contents of our mind.

It postulates that the fundamental reality is Quality or value. All things come from Quality, and it is Quality that draws all things into being from Quality. All that exists is a form of Quality, and nothing exists without Quality. You could say that Quality is one of the names of God.

The first distinction that is made in understanding Quality is a distinction between Dynamic Quality (DQ) and Static Quality (SQ). DQ cannot be named and cannot be described. It is the cutting edge of experience. It is pre-intellectual awareness. DQ does not fit into any intellectual system; it is the ragged edge at the border of all such systems. DQ is the driving force of evolution, the lure (or: telos) which all of existence pursues.

Sometimes, a DQ driven evolution creates an evolutionary leap. Something new comes into existence. For this new thing of value to be maintained in existence it must 'static latch'; that is, it must be able to generate a particular pattern of value which persists over time, either on a continuous basis or a continuously regenerated basis.

These static latches form the known world. They are the stable forms of Quality.

Static Quality can be named. It can be classified and analysed. The principal classification of SQ is a division into four levels. These levels are discrete and do not overlap. Moreover, all that we presently know can be classified and described according to these four levels, except for DQ itself, which, to repeat, remains outside of all realms of classification.

The four levels are: inorganic, organic, social and intellectual. (For the sake of simplicity the inorganic can be taken to include the quantum level, although perhaps this level could constitute its own 'zeroth' level).

The inorganic level refers to atomic and molecular behaviour. Any object can be viewed as existing at the inorganic level. For example, a rock is a pattern of inorganic value - it's constituent parts value their current relationships more than any other alternative (eg disintegration). In the original flux, before there was either matter or time, Quality was found to lie in a certain structuring of quantum forces. [Here an astro-physicist can fill in the gaps].

The inorganic level is shaped by the laws of physics. These laws are a codification of the value choices made by atoms and molecules.

The organic (or biological) began to develop when a particular molecule made a DQ leap into a different pattern of behaviour. 'Biological evolution can be seen as a process by which weak Dynamic forces at a subatomic level discover stratagems for overcoming huge static inorganic forces at a superatomic level.' The highest quality static latch at the organic level was the molecule DNA. In practical terms this level can be considered as anything which can be described with reference to DNA.

The organic level is shaped by the law of natural selection. This law is a codification of the value choices made by organic patterns of value.

Uniquely (so far as we know), the human species is able to experience two further degrees of static quality.

The social level is the 'subjective customs of groups of people'. This sense of 'social' does not apply to anything non-human. The DQ innovation and static latch which enabled the social level to come into being was the development of language. It is possible that this static latch was supplemented by the further DQ innovation and static latch of ritual, but that is a moot point.

The social level encompasses an enormous variety of human behaviour. It can be understood through the values which govern it. The social level is shaped by laws, customs, mores and religious practices (eg against murder, adultery, theft) which are enforced by soldiers, policemen, parents and priests. These laws are what preserve the existence of social patterns of value from a degradation into the biological patterns of value on which the society depends. The social level is also ordered through the celebrity principle, which articulates the governing social values. Celebrities are those people who exemplify the values of the society, and who gain social rewards (principally wealth, power and fame) as a result.

The intellectual level is 'the level of symbolic social learning', the 'same as mind'. It is the 'collection and manipulation of symbols, created in the brain, that stand for patterns of experience'. The DQ innovation and static latch which enabled the intellectual level to come into being has not been satisfactorily determined.

The intellectual level is shaped by the notion of 'truth', which stands independently of social opinion. There is no link between celebrity and truth. The guardians of the intellectual level are, variously, the members of the Church of Reason. Intellectual 'laws' (eg logic) are a codification of the value choices made by intellectuals.

A culture is a combination of social and intellectual patterns of value. The twentieth century can be understood as a contest between social and intellectual patterns of value.

So: a quick recap on the key terms.
Quality - source of everything (I think of Quality as being one of the names of God, ie it conveys something about God, but is incomplete).
Dynamic and Static Quality - the first division in our understanding. Dynamic Quality (DQ) can't be defined (the Tao that can be spoken is not the eternal Tao). Static Quality(SQ) is everything that we can talk about.
The four levels: inorganic, organic, social and intellectual, in order of ascending value.

My heresy is that I don't think level four is `intellectual' - and I think there are all sorts of profound problems with it. I would rechristen the fourth level as `eudaimonic', and understand how it works differently - and I've written a longish essay on why which can be accessed via the moq.org website.

Pirsig's Metaphysics - in my view - asks better questions of Reality than anything else I have seen - albeit my exposure to Metaphysics is limited. There's also an interesting analogy with Maslow's hierarchy of needs here, of course.

Note that Pirsig confines himself to four levels, and the diarist - who is from a Christian tradition - has "issues" with the fourth and "highest" of the levels.

Now it seems to me that it is in this fourth - Intellectual/ Spiritual/ Emotional? - level that the guerrilla warfare is being fought out on ET - and, come to that in many other fora.

The second piece of "background" is personal.

About a dozen years ago - when I was just finishing my stint as a "top dog" in a global futures exchange - my ex went to see "Mary Rose", a psychic/ tarot reader who had been recommended to her by a friend. After this, she pestered me on and off for 6 months or so to go and see her, while I poo-poo'ed the whole thing as a good (well, pretty useless, actually) applied mathematician should.

In the end, I was prevailed upon to do so, just to shut my ex up on the subject, and duly caught the train down to Greenwich. I was surprised that "Mary Rose" appeared quite normal, and after introducing myself, she took a tarot pack and started off on a "reading".

Now, at this remove, I cannot remember all of the reading but a few examples of things she said stay with me:

She referred to places, and to names. She saw "Holland" for instance - was that relevant? Yes, I said, I had just that afternoon booked a flight to see an exchange CEO in Amsterdam (which my ex did not know, and would not have interested her if she had). You'll get what you want there, she said, and I did.

She saw "Robert", who was recently dead, and "Canada". A friend of mine, Bob Purves, formerly of the Winnipeg Exchange (whom my ex did not know and had never met) had very recently died. She said that he was a (Taurean? I think). I had no idea, but when I checked, he was.

She asked if I had a car. Yes. Be careful with the steering and brakes she said.

Within a week my ex had parked the car in our drive, which was at 90 degrees off a steep hill, but left off the brake, and failed to straighten up the steering. The car duly trundled off down the hill and caused a few hundred quids worth of damage...

There were other instances, but the long and short of it is that since meeting "Mary Rose", whom I returned to a few times over the years, I have been convinced that there is another level of "consciousness" or maybe "awareness" in which some people have an ability.

This is of course not susceptible to any sort of "proof" and I don't think it is to be relied upon to the exclusion of more "rational" decision making.

The point of all this is that whatever the "truth" is of our "reality" we have to approach it on the basis of our own experience, and, moreover, IMHO on the basis that the "Either/Or" scalpel of Reason is a deeply imperfect way of approaching whatever it is that is "out there".

Not Northern Rocket Science

by ChrisCook Mon Dec 17th, 2007 at 09:54:18 AM EST

Well, here's an essay I did on the subject of Northern Rock, and the possibility of a "Third Way"...

A Northern Rock Partnership

The "conventional wisdom" is that there are only two options for Northern Rock: "Public" - through nationalisation and State ownership; and "Private" through continuation as a Public Limited Liability Company backed by possibly unlimited "tax-payers' money".

In fact, there is another way - a new synthesis of Public and Private - in which Northern Rock could be restructured, and for which all of the elements are already in place and which requires neither legislation nor a single penny of "tax-payers' money".

The enabler of this solution is that simple but infinitely flexible new corporate body - the Limited Liability Partnership" ("LLP") now coming into use throughout the commercial and public sectors in ways never envisaged in April 2001 when the LLP was introduced to limit the liability of professional partnerships.

Examples include: City of Glasgow (twice); Standard Life's private equity operation, "SLIPE"; Scottish Widows; First Hydro and an innovative LLP involving the Hilton group.

Introducing the Capital Partnership
A Capital Partnership LLP is not an "Organisation" but a framework within which "stakeholder" Members "self organise".

A Custodian owns the assets of the enterprise as a "steward" or "trustee" and may also have certain governance powers as a guardian of the purpose - or "Aims" - which the enterprise was incorporated to achieve.

An Investor or Capital member introduces money or "money's worth" of (say) land, buildings, intellectual property.

A Developer/ Operator Member uses the Capital to achieve the purpose of the enterprise, and shares the revenues with the Investor in agreed proportional "units" or "Equity Shares". e.g. millionth's or billionth's.

A Northern Rock Partnership could be structured as follows.

Custodian
Firstly: the Northern Rock Foundation already owns 15% of Northern Rock Plc, and receives 5% of profits which it has historically applied, extremely successfully, to good causes.

Secondly; as has been recently documented in the Press, the Northern Rock "Granite" vehicle is an exemplar of the SIV's which have been constructed throughout the UK mortgage industry to allow securitisation of mortgage loans and involve technical "ownership" of assets by charities which are typically not even aware of the staggering scale of assets and liabilities nominally held in their names.

Shareholders would transfer their shares to the Northern Rock Foundation, and would in return become Investor Members - see below. The existing trust arrangements for the Granite assets would also be transferred from the Down's Syndrome North East Association (UK) - the unwitting existing beneficiaries - to the Northern Rock Foundation.

Investors
The key Investor is currently the Bank of England, while the Treasury has a minor direct interest through the 1.25% penalty payment being applied to Northern Rock, and which is "rolling up" as a "subordinated loan". The Treasury also has a very large contingent liability, in respect of deposit guarantees.

As Tim Congdon revealed in the FT recently, politicians, press and public alike are under a misapprehension as to the true position.  The money being loaned by the Bank of England has in fact never been anywhere near a tax-payer and is created by the Bank of England by the "stroke of a pen" - or more likely, with a "click of a mouse" - in the same way as it creates bank-notes, also to provide necessary liquidity.

The privilege of money creation gives rise to income known as "Seignorage" and the true position, as pointed out by Tim Congdon, runs entirely contrary to general perception. The 5.5% interest levied by the Bank of England on its loans is in fact pure profit, since the cost to the Bank of England of this credit creation is zero.

So the true position is that the greater the loan, and the longer this goes on, the greater will be the "profit" to the tax payer in terms of seignorage, and of course this "profit" will be available to offset any potential loss to the taxpayer if shareholder funds were insufficient to cover Northern Rock losses.

My proposal, building on a suggestion from Hector Sants of the FSA, is that it is possible for the Treasury to make a virtue out of necessity by routing all "seignorage" payments by Northern Rock to the Northern Rock Custodian member of a Northern Rock Partnership and for the resulting "Pool" of funds to constitute a "Default Fund". Clearly the Treasury/FSA etc would require representation on the board of the Custodian.

After making the necessary provisions into the Default Fund, the balance of Northern Rock net revenues would be divided between the other Investors ie the shareholders and the Developer/Operator which would essentially constitute a "Cooperative" of staff and management not dissimilar to the John Lewis Partnership, and bolstered by new and innovative management.

A New Asset Class?

In Canada there are essentially two Capital Markets: the conventional market in listed Company stocks, and a parallel market in "Income Trusts" consisting of units in the gross revenues of these listed Companies, created using trust law.

It would be straightforward for a market to develop in proportional "units" or "Equity shares" e.g. billionths of gross revenues flowing through a Northern Rock LLP. While for tax reasons this would not be currently practicable for UK pension investors, it would be attractive to overseas investors not least because the structure is to all intents and purposes a "Sukuk" in structure, and Islamically sound at a deep level.

The effect for existing shareholders would be that they would be participating in the revenues of Northern Rock alongside, rather than after, the management and staff - which is the not unattractive proposition which accounts for the popularity of Income Trusts in Canada.

Outcome

In summary, Northern Rock Plc would be gradually "dis-intermediated". Any necessary money not available from Depositors will be created either by the Bank of England, or directly by the Treasury, and a provision (essentially a charge for the use of the government guarantee) - set at a suitable level - would be levied upon Northern Rock and held as a "Default Fund" by a Custodian.

A proportion of the net revenues would be shared between the existing shareholders - now as Investor members of the Capital Partnership - and the management and staff, thereby aligning their interests. Any excess from the Pool/ Default Fund could be available for public purposes, such as investment in affordable housing.

ET ThinkLab

by ChrisCook Thu Nov 8th, 2007 at 04:45:17 AM EST

A request from siegestate for ET assistance is in this morning's Klatsch.

It's entirely in line with the current Migeru-sparked Bootstrapping the ET Think Tank , and Sven Triloqvist's spin-off Bootstrapping ET practical.

There was some approval of "ET Think Lab" as a "brand" for the sort of loose "meta-consultancy" / networking etc now possible within an ET "umbrella".

I have advocated for some time a simple partnership-based framework within which ET'ers might cooperate, and I understand from Paul Spencer that he is working on a draft protocol for such an "umbrella".

As a practical point we might usefully create on the site a new sector "ET Think Lab" sector analogous to "Debates" so that the relevant threads don't disappear too soon off the ET radar screen.

Anyway, over to siegestate:

Will someone please erase this if it is not within acceptable bounds?

I am starting a company and need advice in 3 areas. Is there anyone in the community whose expertise deals in:
1 - ISO9001 protocols, defining, advancing
2 - using software such as Moodle for on-line training
3 - where does one set up an international, substantially on-line company these days?

Of course, the company will be worth billions very soon, but now it is nothing, so walking into Monaco to set up a Gibraltar company operating from the Isle of Mann wouldn't impress anyone. We aren't really Chamber of Commerce friendly since we won't be hiring scads of people-the inspectors will be hired freelance and world-wide on an as needed basis.

Sunshine in Berkeley

by ChrisCook Wed Nov 7th, 2007 at 07:52:09 AM EST

This story and clip from CBS concerns an interesting municipal initiative from that hot bed of California radicalism, Berkeley.

Berkeley Solar Utility

Berkeley municipality voted last night to initiate a programme of municipal (subsidised?) loans to Berkeley residents to finance the installation of solar panels.

But, the Devil's in the detail, and the Berkeley municipality Executive has now got to come up with a fully worked through proposal.

But the principle of charging not the individual, but the property - collecting repayments through an "assessment" in the same way as property taxes - is a good one.

The questions that need to be addressed include:

• whether the claims of the solar panel salesmen stack up;
  
• quality control of both panels and installation;
  
• the requirement for smart metering;
  
• the relationship with the utilities who would buy the surplus energy;
  
• funding sources;
  
• tax issues.

This would be to create an "Energy Pool" whereby investors can buy "Energy units" in a Pool of future solar production, and conventional dollars are loaned interest free by the Pool to residential properties  for installations of solar panels, or anything else that stacks up in terms of "energy payback" over time.

The resulting "Energy Loan" of x,000 KiloWatt/ Hours is then repaid via energy utility billing systems.

Investors receive no interest on these "Energy Units", but they are able to "hedge" against energy price rises, and they can either sell units or exchange them in due course for electricity.

The result is quite close to the increasingly popular "Exchange Traded Commodity" funds invested in energy, but with additional capabilities.

Indeed, it would open up the way for a new form of currency - an "Energy Dollar" or even a "Carbon Dollar" - consisting of a fixed unit of energy.

Kilowatt Cards show the possibilities for such an "Energy Currency", although that is a project by a charity which has yet to think through its enterprise model.

Tax Goes Banana's - Richard Murphy Blog

by ChrisCook Tue Nov 6th, 2007 at 07:32:29 AM EST

Richard Murphy - both an expert forensic accountant and clear and cogent writer -has some great posts on his Blog Tax Research

with some notable research into the Northern Rock structure, referred to in ET.

He tells me that he has some more Northern Rock meat coming soon. But the following, based as it is on an exceptional Guardian lead article today

Revealed:how multinational corporations avoid the taxman

is worth cross posting, with his permission.

The Guardian's front page this morning is dedicated to a single story. It leads with the comment that:

Global banana companies supplying the UK are using tax havens to avoid paying tax on their profits here and in developing countries.

And it continues by saying:

The investigation reveals that large corporations are creating elaborate structures to move profits through subsidiaries to offshore centres such as the Cayman Islands, Bermuda and the British Virgin Islands, to avoid handing money over to tax collectors in the countries where their goods are produced, and in those where they are consumed.

Governments at both ends of the chain are increasingly being deprived of the ability to raise tax for development or services.

The result is simple. As the Guardian notes:

Dole, Chiquita, and Fresh Del Monte, the three companies that supply several UK supermarkets and between them control more than two thirds of the worldwide banana trade, generated over $50bn (£24bn) of sales and $1.4bn of global profits in the last five years. Yet they paid just $200m, or just over 14% of profits, in taxes between them over that period, our analysis of their financial accounts reveals.

But this overstates the case in some periods and locations:

In some years the banana companies have paid an effective tax rate as low as 8%, even though the standard rate in the US where they have their headquarters and file their full accounts is 35%.

In the UK the situation is worse:

Del Monte Fresh Produce UK, Chiquita UK and Dole's UK business, JP Fresh, report combined sales in the UK of over £400m in their most recently filed annual accounts. Yet between them they paid only £128,000 in UK tax.

How does this happen? It's simple. As the Guardian notes in the second part of the report:

Think of Jersey and you think prosperous tax haven, or perhaps offshore financial centre as it prefers to be called.

But exporter of bananas to the UK? Surely not. Banana boats from the Windward Islands have never actually jostled with luxury yachts in its immaculate marinas, of course, but on paper a substantial volume of banana trade from the Caribbean has passed in the last 15 years through Channel Island-based offshore subsidiaries and joint ventures owned at various times by Fyffes and Geest.

This has long been a story John Christensen and I have told for the Tax Justice Network. It's good to see it so widely reported now. And it's important that other stories are told as well, like these:

Fresh Del Monte is registered in the tax haven of the Cayman Islands, and has more than 30 subsidiaries based on the islands, where the rate of corporation tax is zero. It also has subsidiaries in other tax havens and low tax jurisdictions that include Gibraltar, Bermuda, the Dutch Antilles and the British Virgin Islands.

Why is this important? Well, as the Guardian explains:

Bananas are highly profitable - they are the largest single item by volume sold in British supermarkets and the third largest in value.

But the most intriguing thing about bananas to the companies who sell them is the way they can be packaged for financial engineering:

Transnationals have developed ways of bundling up parts of their business such as intellectual property, brands, logos, marketing, insurance and finance expertise and owning them offshore.

They can then charge for the use of these to other parts of their group onshore. In this way a banana may be sold by one subsidiary of a group in the country where it was grown to another group subsidiary offshore at little more than the cost of production in the originating country.

The banana ends up being sold back onshore to a further subsidiary of the same company in the consuming country at a price that is close to the final retail price.

The result?

In between, royalties for the use of brands, distribution networks, insurance, finance and marketing charged to the subsidiary in the final destination country can be made to accrue to subsidiaries based offshore in low tax areas.

Through transfer pricing, the taxable profit on transactions at either end of the chain, in Latin America or in the EU or US say, is kept low. At Fresh Del Monte, the company had 48% of its sales in the US in 2005 but lost $35.2m in that country. Overseas it made a profit of $133.5m. It paid no US tax but was instead given a tax credit of $8.3m that year.

In fact, the Guardian estimates that for very £1 spent on bananas the split looks like this:

1. 13p to the growing country: 1.5p is labour, 10.5 p is costs and 1p profit;

2. 8p to a Cayman company for use of the `purchasing network';

3. 8p to Luxembourg for use of `financial services';

4. 4p to Ireland for `use of the brand';

5. 4p to the Isle of Man for insurance;

6. 6p to Jersey for management services;

7. 17p to Bermuda for `use of the distribution network';

Which gives rise to a 60p sale price into the UK.

8. 1p of profit is declared in the UK;

9. The retailer makes a margin of 39p.

Which makes £1.

In summary therefore, 47p of the price you pay ends up in a tax haven. Now of course, some services are supplied for that sum. I don't deny it.

But what are they worth? I'll guarantee you, on an arms length basis they're worth nothing like the price paid. And the structure and location of those services is designed for one purpose: to make sure that neither the UK, US or the countries of origin get the tax they are due.

I call that abuse. And I applaud the Guardian for exposing this. And I should add, I am quoted in the article and was involved in discussion of it before publication, as was my colleague John Christensen who is also quoted.

What I might have added to it is an analysis of that 39p margin the UK. Just 2.2p of this will be declared as profit before tax. And the tax rate paid will be less than 30% (unsurprisingly). So maybe 0.5p will be paid in UK tax.

Sobering, isn't it? After all, how much would have been paid if all the offshore component had been taxed onshore? I can't say for sure - but I can say this: it would have been much more. And if we had unitary taxation in the UK, as the Tax Justice Network has called for that would be the result.

Bank of England - UnPlugged

by ChrisCook Fri Nov 2nd, 2007 at 08:05:09 AM EST

There has been much discussion on ET re Northern Rock and this

Northern Rock as Tax payers goldmine

appeared on the FT website and in the FT today.

Now, this article blows wide open the current deficit-based charade of a system we have, and the strange role of Central Banks within it.

The article deals with the Bank of England's role in the Northern Rock fiasco and asks

Is there a serious threat to Britain's public finances? Is a large sum of public money at risk?

and then analyses exactly why this is in fact a "nice little earner" for the BoE, if not for the Northern Rock shareholders.

So

The answer - paradoxically - is: there is no damage at all. On the contrary, the £30bn rescue of Northern Rock will boost the central bank's profits and reduce - yes, reduce - the budget deficit by £2bn.
 

and the explanation

The explanation is that the Bank of England can create money "by a stroke of the pen". Parliament has made it the UK's only issuer of legal-tender notes, and it can expand the note issue or credit a balance convertible into notes at virtually nil cost.

Because of these special powers, the Bank does not need to borrow in the interbank market at a positive interest rate.

Instead the interest cost on its £21bn loan (and indeed its £30bn loan if it reaches that level) is zero. So the Bank's profit on the operation in the circumstances discussed would amount to about £2bn (that is, 6¾ per cent on £30bn).

Congdon then goes on to explain why it is that the Bank of England cannot do this for everyone who wants interest-free credit.

Like me. And the answer is of course that I might not pay it back.

Cost of Credit?

The actual function of Banks as credit intermediaries is in fact to guarantee the credit of the borrower. The cost of that guarantee is a combination of system cost and default costs.

This cost bears no relation to the arbitrary interest rates set by Central Banks, and we have recently seen the relationship between the rate set by Central Banks and that charged by clearing banks diverge.

In fact banks have been accustomed for some time now to "outsource" to investors their guarantee risk. The credit derivatives that they use are essentially guarantees of finite duration.

There is a crucial qualitative distinction between unsecured credit - which is backed only by future earning power of individuals and corporations - and "asset-backed" secured credit.

This is that productive assets such as Land (which backs Northern Rock's loan portfolio) actually underpins more than two thirds of UK money in existence.

It is the stream of "use value" units of land and property - let's call them "Square Metre/ Years" which has the "Value" in exchange for which we are accustomed to exchange other forms of "Value" eg our time value through the medium of money.

Now, the actual "cost" of such "Capital" (albeit Land has been essentially defined out of existence by conventional Economics) is a matter of supply and demand.

Cost of Capital?

But what actually is the true Cost of Capital (as opposed to the arbitrary Cost of credit and hence the financial capital consisting of "Money as Debt")?

Gregory Clark The Industrial Revolution Unplugged: and Interview with Gregory Clark had interesting data here, but drew the wrong conclusions.

It turns out we have very clear evidence of changes in peoples preferences over this long pre-industrial interval. The example the book gives is that people were becoming more patient as the Industrial Revolution approached. The measure of patience in these pre-industrial societies is the interest rates?

Because the interest rate tells you much you have to reward people to own land or own houses. How much do you have to pay them not to consume immediately, but instead own that asset and wait for future consumption? If you go back to ancient Babylon they had mortgage markets but the interest rates were typically twenty to twenty-five percent.

If you go to medieval Europe their interest rates were ten to twelve percent for things like land. By the eve of the Industrial Revolution the return on land in England dropped to about four percent. So in the pre-industrial world interest rates seem to indicate the amount of patience people are exhibiting.

Clark wrongly assumed that people are getting more patient (and less greedy?) because he assumed that a return on capital has always been based upon the "Cost of Credit".

It has nothing to do with peoples' preferences and everything to do with a market price for Capital.

The supply of productive not financial Capital has been growing over the ages so that the world in awash in it, and hence the price is now very low in real terms.

Medieval England had absolute price stability. It had almost no government debt. It had very strong security of property. People who invested in land in local villages, who needed a ten percent return in order to make that investment, had absolute property security.

It was because there was no deficit-based money that there was no inflation.

What I am getting to is not that Treasuries or Central Banks should issue credit interest-free (although they could, as the Social Credit movement advocated) but that we should look at new ways at which "Value Units" such as Land Rental Units and   Energy could be created using "Equity" or "Asset-based" solutions.

In the dis-intermediated "Clearing Union" model I advocate, Banks become service providers, and Central Banks like the Bank of England  -currently bailing out Northern Rock - are entirely redundant.

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