But we are only complying with the law

Shamed by their excessive use of tax avoidance schemes, Barclays have fallen back on the excuse of last resort; "we are only complying with the law".

As an aside, Barclays has a less than perfect record of following the requirements of UK legislation, as various judgements from the Financial Services Agency will attest. Moreover, UK corporate tax law is notoriously complex. It is an unequal struggle between the slick accountants from Barclays and the disaffected and underpaid tax inspectors of her Majesty's Customs and Excises.

Still, it is hard to understand why tax inspectors can't squeeze more corporate tax payments from Barclays. The company just reported their results online and 2010 was a very good year. Profits amounted to about £6 billion. Roughly speaking, around a third of these profits came from retail banking operations, the bulk of which were generated in the UK. The remainder came from Barclays capital, the investment banking operation primarily based in London.

For tax liabiilities, location matters. Corporate income tax, in theory, should be levied on the profits made by firms in a given geographical region. Judging by the financial statements, the majority of Barclays operations as well as their employees are based in the UK. Yet curiously these UK operations never seem to generate significant amounts of corporate income tax payments.

Barclays have tried to hide the paltry amounts of corporate tax payments by publishing the total tax amounts that the company paid over to the Exchequer. For example, they have included the amounts of PAYE paid by their employees. In 2009, the bank paid around £2 billion over to HM Revenue & Customers, although £113 million was corporation tax.

This only adds to the mystery as to why corporate income tax payments are so low. High levels of PAYE payments point to high underlying salary payments. Normally, companies don't pay out massive wads of cash unless their workers are generating large profits. Aren't bank bonuses supposed to be tied to profits?

Companies have an incentive to hide those profits from the taxman. Otherwise, how could one explain the massive financial flows into the Cayman Islands; a barren rock in the middle of the Caribbean. Banks have taken advantage of the complexity of corporate income tax regulations. They have arranged their financial operations so that they are now effectively liberated of any responsibility to pay taxes.

However, our Parliament is sovereign. We can determine our own tax laws. If the political will was there, Barclays would not be able to avoid taxes in such a scandalous way.

One simple way forward would be for corporate income tax on banks to become a presumptive tax. At the end of every quarter, the bank would have to pay a fixed proportion of its PAYE contributions as an advance payment on future corporate income tax liabilities. A rate between five and 10 percent would be reasonable.

These funds could be held in escrow accounts. At the end of the year banks would have to justify why those profits should be allocated to offshore centres. If they can genuinely prove that the profits were generated through operations conducted abroad then they can receive a rebate on corporate tax payments. However, the level of proof required would have to be extremely high.

The idea isn't that radical. Presumptive taxation is quite common worldwide as well as advance payments on corporate income tax. It would offer a way of genuinely cracking down on these outrageous tax avoidance schemes that banks have abused for years. If Barclays don't like it, then they put all their ATMs on the Cayman Islands.

Watch out Mervyn, the press are starting to turn....

The UK press are starting to question Mr. King's competence...


The Guardian

His letter to George Osborne had a familiar ring about it. Yes, inflation remained well above target, but that was due to the weakness of sterling, rising commodity prices and the increase in VAT. For some in the markets, this explanation is wearing thin, and has become as unconvincing as the boy who tells teacher that the dog ate his homework.

The Telegraph

Cheap money has thus not only fuelled inflation, but has created a climate in which talk of any rate rise triggers concern that we may be tipped back into recession. Stuck in this vicious circle, it is no surprise that Mr King openly acknowledged yesterday that the MPC is split on the future direction of policy.

BBC

Mervyn King's 10th letter to Number 11 Downing Street is similar to many of the other ones he's written. In his view, the 4% rise in the CPI in the past 12 months is unfortunate - but temporary, and almost entirely driven by factors beyond the Bank's control. He insists that the MPC has not "lost control of inflation".

The Spectator

Now that today’s inflation figures are up, to a predictable and predicted 4.0 percent on CPI and 5.2 percent on RPI, we can expect the usual response. Nothing from the government (even though the declining standard of living will eclipse cuts as the no.1 problem of 2011); plenty of shocked news stories; and, then, the round of commentators saying that Mervyn King should “hold his nerve,” and not increase the absurdly low base rates of 0.5 percent. Inflation is temporary, he says, and should be okay again this time next year (that’s what he said about the start of 2011).

A good day for senior management at Barclays; a terrible day for the rest of us

Yesterday, the consumer price index was published, showing that prices are rising at 4 percent a year. The governor the Bank of England tried to explain this outrageous number by suggesting that higher prices are due to temporary factors. He must have forgotten that UK inflation has been consistently above the two percent target since 2006. Perhaps Mr. King operates on another temporal dimension, but nearly five years of above target inflation doesn't sound that temporary to me.

Under normal circumstances, a responsible central bank wouldn't hestitate to raise interest rates in the face such an appalling degeneration of the inflationary environment. However, nothing is normal about current UK macroeconomic policy management. Yet, even as the inflation numbers deteriorate at an alarming rate, Mr. King continues to resist the idea of raising interest rates.

His reluctance stems from a belief that protecting the UK banking system is more important than confronting inflation. Banks are undercapitalised and keeping interest rates low boosts their profitability. Banks can now borrow funds from the central bank at 0.5 percent and buy a government bond for 4 percent. Making money has never been easier.

With such a benign monetary regime, it might be reasonable to think Mr King should expect some reciprocity from commercial banks. It would be helpful if banks shared his concerns about undercapitalisation. Profits could be pumped back into banks to strengthen their balance sheets.

Today, Barclays had an opportunity to respond to all that love and kindness from the Bank of England. It published their end of year results. What did Barclays do? They gave their staff a huge pay increase. Last year, staff costs increased by an astounding 20 percent.

As our collective living standards are slowly crushed by higher prices and stagnant wages, we can ponder on the delicious irony of that extraordinary pay increase. Our central bank has engineered a rapid increase in inflation, either by accident or design, so that Barclays bank can increase salaries, in real terms, by 16 percent.

How cheap dresses and fancy shoes led to the financial crisis

Fashion has never been cheaper.

Since 2000, the ratio of clothes and footwear prices to hourly earnings fell by almost 60 percent. Around half of that decline was due to the direct effects of lower prices; the other half came from higher nominal wages.

This chart illustrates this spectacular fall in the real price of clothing. It also demonstrates the extraordinary structural change that has occurred in the world economy over the last 10 years. There was a time, and it wasn't so long ago, that Britain had a textile industry. That industry has all but disappeared. Instead, all our clothes are produced overseas, mostly in East Asia, particularly in China.

This chart doesn't just highlight the disappearance of a single British industry and the rise of China as an economic superpower. It also explains how the Bank of England made some profound errors in the conduct of monetary policy. The bank wasn't looking too closely at the sudden profusion of style around Threadneedle street or the meteoric rise of Jimmy Choo. If they had noticed, they might have avoided the greatest economic and financial disaster for generations.

As clothing and footwear prices fell, it should have provided powerful downward pressure on the overall price level. Yet throughout the last decade, consumer prices continued to increase.

Until 2006, that increase was around 2 percent a year. Although this inflation rate doesn't sound too serious, it obscured huge shifts in relative prices. If clothes prices were falling sharply, other items had to be going up in order for the overall inflation rate to be two percent. In reality, cheap Chinese imports were hiding a lot of inflation.

Low headline inflation lulled the Bank of England into a false sense of security. It chose to ignore the fact that cheaper imports were distorting true underlying inflationary dynamics. Since the headline inflation rate was within its mandated target of two percent, all was well with the world. Therefore, the only sensible thing to do was to reduce interest rates to historically low levels.

This provoked a borrowing frenzy. The primary destination for cheap credit was the housing market. The Bank of England couldn't fail to notice the double digit increase in house prices. However, it argued that it wasn't the job of a central bank to target asset prices. The CPI was the thing that mattered, and that was under control.

Despite this neat excuse, the borrowing frenzy wasn't just confined to the bubblicious real estate sector. Lower interest rates also encouraged households to fund consumption expenditure with a huge increase in personal debt. Flat screen TVs, new cars, home extensions, and extravagant holidays to Asia were all funded by cheap loans from high street banks. Behind all this debt accumulation was the Bank of England, with its low interest rates, and a belief that inflation was under control.

Then, it all fell apart. There is no need to recycle the sequence of events that led to the financial crisis. It is suffice to say that from 2007 onwards, banks failed and households either could not or would not continue borrowing to finance consumption. Aggregage demand crashed, and GDP fell through the floor, taking a sizable chunk of tax revenues with it.

As the crisis unfolded, the Bank of England impotently tried to revive the economy with lower interest rates. Despite the dramatic cuts in the bank rate, the UK economy dived into the deepest recession since the war. The Bank of England was also suckered into resuscitating the banks, who quickly sucked in huge amounts of taxpayer’s money. Before you could say "Clements Ribeiro makes nicer dresses than Georges Chakra" every major economic indicator was pointing in the wrong direction.

What was it that drove Britain into this sorry mess? Superficially, it looks like interest rates. Search a little deeper and we see that for 10 years the Bank of England ignored the fact that clothing and footwear prices were falling in absolute terms. Instead, they focused on the aggregate price index and an inflation target that was almost certainly too high. This negligence gave them the justification for excessively low interest rates.

This chart has a twist. Since the beginning of 2009, clothing and footwear prices are no longer falling. In fact, over the last year, clothes and footwear prices have increased by two percent. While this is lower than the overall level of inflation, it points out that the Bank of England can no longer rely on low wages in China to keep UK inflation down.

Those days are over.

The food price shock - lets talk timing before we blame the weather

Over the weekend, I wrote a post on the recent surge in world food prices. Happily, it turned up as a link on a number of websites, so was one of my more widely read pieces. The post argued that the recent food price shock was primarily due to the world wide decline in interest rates.

This isn't a terribly popular view. The prevailing wisdom says that world food markets have undergone a radical structural change. On the demand side, Asia is growing, both in economic terms and waist bands. The continent is munching on burgers and pastries and it now firmly on the road towards obesity; a path that Western economies have been treading for nearly half a century.

There have also been a couple of well publicised supply problems. Certain commodities, such as sugar, and to a lesser extent, wheat have suffered bad harvests. As a practical matter, most of these shocks have been quite recent are therefore likely to affect future rather than current supply. Nevertheless, these poor harvests have been described in apocalyptic terms. The end times are near, and judgement day will soon be upon us. Climate change has wrecked agriculture from the Russian steppe to snowy mountains in Australia.

To summarize, there are three parts to the conventional view; higher world demand, supply shocks, and climate change. How seriously should we take these arguments.

Lets pick the easiest off first - climate change. I am fairly agnostic about whether the world is warming up. I just don't know. I am not a meteorologist. Nevertheless, I know one thing. This process, if true, will take many decades. Climate change won't burst upon us in six months and wreck our food supply.

The Asian demand argument is also unconvincing. Why? Take a look at the chart above. It traces out the UK CPI price index for all food items, divided by average earnings. This chart tells us how much food costs in terms of the price of UK labour.

The chart tells us that between 1996 and 2007, food in the UK became a lot cheaper relative to labour. There could be some honest debate about the precise turning point. Nevertheless, the chart points out that food prices rose sharply relative to UK wage rates as soon as the financial crisis took hold. So where is the Asian growth story in this picture. I would say it isn't there. Asia was growing rapidly throughout the decade before the crisis and food was becoming cheaper; much cheaper.

Now, I know that this chart is picking up a lot of other things; like the sterling depreciation, and the recession. My point is just about timing. Just to make that point one more time, could Asian growth explain that chart.? Could the weather in Russia or the floods in Australia? Call me a weathergirl, but I don't think so.

The last argument - the supply shocks - is the most difficult. There have been shocks, and prices should rise in response. The issue is one of magnitude - should these shocks have generated double digit increases? All commodity prices are on the rise, including those that have experienced no such supply shocks.

Supply shocks are in the mix, but it is monetary policy that is baking the inflationary pie. There is lots of liquidity pouring into commodity markets. Speculators are doing their thing; responding to incentives, and trying to turn a buck. Meanwhile, the rest of us are paying more for our food.

Yes, there is plenty of waste in the Equalities Commission

For decades, there was a long standing suspicion that government departments waste huge amounts of taxpayers money. However, the data was never there to confirm this view.

That has now changed. The coalition has forced government departments to publish their expenditures over £500. Everything is online now.

Today, I downloaded the December expenditure for the Equalities and Human Rights Commission. Then I set myself the task of cutting at least 7 percent of their expenditures without reducing staffing costs.

In December, the Commission spent £1.7 million. Around 30 percent went on salaries, 25 percent on grants and a staggering 17 percent on rent (lets hope that latter amount was a quarterly not monthly bill).

The seven percent target could have been achieved if the Commission had introduced: a) a staff travel ban; b) stopped "monitoring" the media and Parliament, c) cancelled a conference, d) cancelled some electronic subscriptions, e) stopped translating their documents, and e) fired an overpaid Barrister. The details are presented in the table above.

One job lost for a 7 percent reduction in expenditures, I am sure it is possible.

One last question, do you think the Commission's "media" monitoring also picks up this blog?

Personal insolvencies - another record year

There is a grim inevitability about the rise in personal insolvencies. In 2010, over 135,000 people in England and Wales were overwhelmed by the debts and took the ignominious route of personal bankruptcy.

For banks, the personal lending business is a cruel numbers game. So long as the profits from personal loans comfortably exceed the losses from debt defaults, they are happy. However, for an individual, seduced by those adverts offering easy cash, insolvency is a personal disaster.

Bankers have no shame (part 233)

Bankers profited when the bubble was roaring. Now, JP Morgan will chew on the gristle and bones. It is going to starting dealing in distressed housing debt.

JPMorgan Asset Management (JPMAM) is taking on the challenge of selling distressed real estate by launching a small fund for institutional investors. J.P. Morgan Global Asset Management Real Estate Assets has launched Junius Real Estate Partners, which will, in part, purchase distressed debt left over from the housing bubble burst in 2008, an event that nearly caused the U.S. financial markets to collapse.

JPMorgan will launch a new distressed real estate fund, although critics say that the firm itself is, in part, the very reason why so much real estate in the U.S. is distressed.The bank is betting that the new fund will do well because it will act as a boutique, even though it is wholly owned by JPMorgan, and will only have seven or eight employees. The employees will have a direct stake in the new subsidiary.

Did JP Morgan know about Madoff?

Why does this story not surprise me?

NEW YORK (CNNMoney) -- JPMorgan Chase executives suspected that Bernard Madoff's investment strategy was actually a Ponzi scheme years prior to its collapse, but did nothing to stop it, according to the court-appointed trustee trying to recove assets stolen by Madoff.

The claims come in a lawsuit filed by trustee Irving Picard against JPMorgan Chase. The suit, filed in a New York bankruptcy court in December, was unsealed Thursday.

The complaint seeks to recover nearly $1 billion in fees and profits and an additional $5.4 billion in damages stemming from the bank's long stint as Madoff's banker.

The complaint contains a redacted e-mail from a JPMorgan risk officer warning as early as June 2007 that Madoff was running a Ponzi scheme, and using the bank to hold his money.

Wall street salaries are recovering - yay!

From the Wall Street Journal.....

When it comes to paychecks, Wall Street's law of gravity is back in full force: What goes down must come back up.

In 2010, total compensation and benefits at publicly traded Wall Street banks and securities firms hit a record of $135 billion, according to an analysis by The Wall Street Journal. The total is up 5.7% from $128 billion in combined compensation and benefits by the same companies in 2009.

The increase was fueled by a revenue rebound as the financial crisis recedes in the rearview mirror. At 25 large financial firms that have reported full-year results, revenue rose to $417 billion, another all-time high, even though last year's 1% increase was just a fraction of the industry's revenue jolt from 2008 to 2009 as trading and investment banking sprang back to life.

Land Registry confirms falling prices

(click on the graphic for a larger version)

According to the Land Registry , UK property prices dropped by 0.2 percent in December - the fourth successive monthly fall in prices.

Nevertheless, the Guardian helpfully located the few remaining bubble boom towns.

Making money from money

"Fifty years ago, the highest paid and most prestigious professions were that of a doctor or a 707 airline pilot who flew the “golden” route from Los Angeles to Honolulu.

Today the yellow brick road begins on Wall Street or the City. Aside from supernova innovators such as Steve Jobs or Mark Zuckerberg, the money is made from securitizing things instead of booting and rebuilding America.

Almost a quarter of the 400 wealthiest people on Forbes annual richest list make their money from money, whereas only 8 percent could make that claim in its first issue in 1982, and probably close to 0 percent when I first read my economic primer in 1966."

Bill Gross founder of PIMCO.

While the statement is undoubtedly true, it is hard to take Mr. Gross completely seriously, since he too made his money from money.

The debt ceiling approaches

It is hard to believe there is a ceiling on US debt. Apparently, there is, and the Federal government is rapidly approaching it.

From Bloomberg...

The U.S. Treasury Department today said it would keep its long-term borrowing at steady levels and warned that the federal debt limit could be reached as soon as April 5.

Mary Miller, the Treasury’s assistant secretary for financial markets, said the department so far is borrowing as usual while Congress debates when and how to raise the $14.29 trillion debt limit. Secretary Timothy F. Geithner has warned that the U.S. faces “catastrophic damage” if lawmakers do not act in time.

“We expect that Congress will do the right thing and raise the debt ceiling in a timely manner,” Miller said at a press conference.

The Treasury today said it plans to sell $72 billion in long-term debt next week, in line with the median forecast in a Bloomberg News survey of bond dealers. The department’s quarterly auctions will consist of $32 billion in three-year notes on Feb. 8, $24 billion in 10-year notes Feb. 9 and $16 billion in 30-year bonds Feb. 10.

We need new generals

Wasn't 2007 the year that the financial crash started, or did I imagine it?

You have to love Goldman; part of the the recent huge bonus payments are for performances dating back to 2007. Didn't the bank nearly go bust less than 12 months later.

Whatever the performance, Goldman execs get paid.

Why are we so unhappy?

So why is there so much unhappiness about inflation at present?

The answer is clear. The three factors I described – higher import and energy prices and taxes – have squeezed real take-home pay by around 12 percent.

Average real take-home pay normally rises as productivity increases – money wages normally rise faster than prices. But the opposite was true last year, so real wages fell sharply. And given the rise in VAT and other price rises this year, real wages are likely to fall again.

As a result, in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.

Speech given by
Mervyn King, Governor of the Bank of England
At the Civic Centre, Newcastle
25 January 2011

Where will future growth come from?

Not from rising labour inputs in Western economies.

You have been warned......

"Overall, it is apparent that the future global economy will not be able to rely on the kind of demographic inputs that helped fuel growth in the era before the current global recession.

For today's affluent Western economies, the coming demographic challenge of stagnant and aging populations combined with mounting health and pension claims on a shrinking pool of prospective workers is already generating concern, especially in Europe and Japan.

But at the same time, demographic constraints in the rising economies that are expected to fuel future global growth are more serious and intractable than generally recognized."

Nicholas Eberstadt
What Population Growth--and Decline--Means for a Global Economy
Foreign Affairs

Clash of the Titans

Who is the daddy?

The Bank of England discover that UK household finances are under strain

How are UK households coping with the fallout of the financial crisis? Staff at the Bank of England recently tackled this question with a survey of households. So, what did they find out?

Like all good social science researchers, they discovered the obvious:

• While the UK economy has recovered, households’ financial positions remain under strain.

• Elevated unemployment, weak earnings growth and restricted credit availability still pose a problem for some households. Low interest rates have helped borrowers.

However, there were some rather more interesting observations.

• The burden of unsecured debt was higher than in the past and concerns about debt levels had increased, leading some to save more in order to reduce indebtedness.

• Households’ awareness of the coalition's fiscal consolidation measures was quite high.

Finally, Bank of England researchers discovered were concerned about the impact on their finances, although the majority had yet to take any action in response.

That sounds familiar, doesn't it?

India's sub-prime crisis

I have always been sceptical about micro-finance as a development strategy for poor countries. Poverty and debt have a tempestuous relationship that goes back hundreds, if not thousands of years. Micro-finance seemed to be fashionable new word for an old idea.

The micro-finance fad was perhaps strongest in India. However, all is not well with the sector as the Hindu Business online reports.

Imagine that your maid borrowed Rs 30,000 from you, promising to repay within a year from her monthly wage of Rs 4,000. Do you think you could cut Rs 2,500 from her monthly wages, every month? First of all, do you expect her to repay anything? Would you charge any interest on your lending?

Most likely, you might write off the entire amount, considering her child's education and husband's health problems.

Microfinance Institutions (MFI) are in a similar situation. According to the Government of Andhra Pradesh, more than Rs 25,000 has been lent to over 80 lakh poor families. On an average each family owes Rs 30,000. Most MFIs charge 27 per cent interest on loans. Some MFIs seem to use strong-arm tactics in loan recovery, with a few reported suicides. The Andhra Pradesh Government reacted with an ordinance to regulate MFIs. Most likely, the MFIs might be forced to write off a big chunk.

Did you note that 27 percent interest rate? Sounds familiar, don't you think?