July 11, 2008 | posted by Michael Baxter in UK economy | comments (1) |

Ann Abraham’s report into the collapse of Equitable Life, due to be published next week, makes damning reading, according to those who have seen a summary of its findings.

In brief, her long awaited report is expected to heap blame on a string of Government bodies, including the former Department for Trade and Industry, the Treasury, the FSA and the Government Actuaries’ Department for failing to adequately supervise the insurer which lost billions of pounds of policyholders’ money following its near collapse in 2000.

But Ms Abraham, as Parliamentary Ombudsman, only has the power to recommend compensation for losses and cannot order the Government to do so. The cost of compensating Equitable’s 1m policyholders is estimated to be £4bn.

No doubt the Government will take its time in considering the report before accepting or rejecting its conclusions, but judging by its previous conduct in such matters, policyholders shouldn’t hold their breath.

The Government’s filibustering on this issue has been nothing less than shameful. It sought to delay the publication of Ms Abraham’s final report for as long as possible by responding to her initial findings last year with a 500-page rebuttal.

Calls for compensation, however, couldn’t have come at a worse time. The Government’s finances are already under strain and are likely to worsen as the economy heads into a recession.

But the Government set a dangerous precedent when it bailed out Northern Rock depositors last October and more recently increased the compensation payable to members of final salary schemes who lost pensions when their companies went bust.

My guess is that the Government will eventually provide some form of compensation, but only after years of wrangling.

The Equitable Members Action Group has already launched 20 regional groups to lobby MPs for compensation and EMAG leader, Paul Braithwaite, has said it will extend the network later, if necessary.

But policyholders had better be prepared for a long haul.

For more on EMAG visit: http://cookham.com/community/equitable/

Posted by Pamela Atherton

July 9, 2008 | posted by Michael Baxter in UK economy | comments (0) |

The FSA’s call for the disclosure of secret stakes in companies built up through derivatives is not before time.

Contracts for Difference, the most popular form of such derivatives, account for a third of equity trading in the UK, presenting significant opportunities for activist investors and hedge funds to build hidden stakes in companies without detection.

The FSA is calling for stakes in London-listed companies, amounting to more than 3 per cent of a company’s shares, which have been built up through derivatives to be disclosed.

The previous situation, whereby investors could establish covert stakes in companies through CFDs without having to disclose them, allowed activist hedge funds and companies planning to launch bids on rivals, to do so by stealth. To add insult to injury, CFD investors in the UK don’t have to pay stamp duty.

The FSA was right to have backed away from its previous proposals requiring only minimal disclosure of CFDs, after it became clear that they would be insufficient to clamp down on abusive practices.

The new rules are also in line with international moves for the disclosure of derivatives, demands for more transparency in hedge funds and increased pressure on short sellers.

Surprisingly, even some hedge fund are in favour of the new rules.  Colin Kingsnorth, head of Laxey Partners, the £1bn London-based activist hedge fund, said he was “absolutely in favour of more disclosure,” even though his fund is well known for its attempt to break up British Land in 2003 through a near 9 per cent stake in the company, built up largely through CFDs.

Others were less enthusiastic. Andrew Shrimpton of hedge fund consultancy, Kinetic Partners, said the new disclosure regime had been prompted by current market turmoil, rather than evidence of market abuse.

Northern Electric, Moss Bros and Marks & Spencer have all been the target of takeover bids from investors who employed CFDs to establish hidden stakes in these companies.

But the CFD disclosure rules are likely to be better received than the FSA’s recent clamp down on short selling during rights issues.

CFD disclosure has been mulled for two years and the rules will not take effective until late 2009, although the FSA has indicated that it would like to introduce them earlier.

Rules introduced last month requiring the disclosure of the shorting of stocks amounting to 0.25 per cent of a company’s shares during a rights issue, were introduced without consultation and at a week’s notice, prompting uproar among hedge funds.

Posted by Pamela Atherton

July 3, 2008 | posted by Michael Baxter in UK economy | comments (2) |

Capital Economics, for long arch bears on house prices, recently predicted that property prices could fall by 35 per cent by the end of 2010.   It reckons 2008 will see falls of 15 per cent, and that the slide will then continue though the next two years.

It is difficult to disagree.  Right now, it seems prediction about how much house prices will fall is really guesswork. The Bank of England’s governor Mervyn King said as much recently, when he said he didn’t know how much house prices would fall.

But with inflationary pressures making it difficult for the Bank to cut interest rates, with the credit crunch making mortgages so thin on the ground, with oil at a level that makes us all blanche, it is difficult to see how price falls will come to any imminent end. 

And while those with vested interests are saying now is the time for buy-to-let investors to move back in, it is difficult to understand why someone would buy a property as an investment in current conditions, even if rent is sufficient to enable landlords to cover interest payments on mortgages.

The IMF recently said UK house prices are 30 per cent overvalued.  That is not the same thing, by the way, as saying house prices need to fall 30 per cent for their value to be right.  In fact if prices are 30 per cent overvalued they would need to fall by 23 per cent to correct this (try the maths yourself).   But markets always tend to overcorrect.  That’s how bubbles work.   Prices go too far on the way up, and fall too much on the way down.

As was pointed out in the article above, it is debatable how much falling house prices will hit consumption.  But if you are like us, or Capital Economics, you think there is a link; and, in fact, Capital Economics reckons consumption will, as a result of falling house prices, stagnate next year.

As you know, the Bank of England is worried about inflation.   It tells us current rising prices are one-offs, but few expect any imminent cuts in interest rates.  Indeed, you may recall, the Bank of International Settlements (that’s the central bank to central banks) said interest rates should go up, everywhere.  The current high price of oil and food, it said, is down to high global demand.    It is all very well the Bank of England or the Fed saying it is an external factor and there is nothing they can do about it.  But actually, that is not true.   Demand for oil is down to everyone, and don’t blame China too much; its oil consumption per capita is a fraction of the level seen in the US and UK.

So, that’s no imminent cut in interest rates, and falling house prices leading to falling consumption.  Throw into the mix news earlier this week from CIPS that its purchasing managers index has fallen to the lowest level it has ever recorded, and you can see the economic prognosis is not so good

Jonathan Loynes, Chief European Economist at Capital Economics said: “The upshot is that, after growth of around 1.7 per cent this year, we now expect the UK economy to expand by just 0.5 per cent or so in 2009 .  What’s more, while the quarterly path of growth is clearly uncertain, we think there is a strong chance at some point of a technical recession in the form of two consecutive quarters of falling output. 

“Whether or not the economy actually enters recession, the consequences of the downturn will be severe. Aside from the drop in house prices, unemployment could rise by almost 1 million by the end of 2010. Meanwhile, government borrowing is set to rise to around £60bn pa, comprehensively breaking the Chancellor’s fiscal rules, while the sterling exchange rate could fall significantly further.”

So where does hope come from?

As we have argued many times before, in such an economic downturn, the price of oil is bound to fall.     Inflation will then fall dramatically, and could turn to deflation fast.  At that time the Bank of England will be able to slash interest rates.

June 24, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Well it’s not going to be pretty, but we should avoid recession.

According to a report from human resources consultancy company Hay Group and the Centre for Economics and Business Research, the UK economy will experience another 18 months of slowing growth, which could hit profits to nigh on £1 billion, and result in up to 350,000 job cuts.  But, it says, the “UK will narrowly escape a full-blown recession.” 

The report was produced from research conducted among ‘senior business leaders.’

It found that business leaders expect profits to fall 1.9 per cent this year, which works out at around £900 million if extrapolated across the economy, but it expects profits to grow strongly in 2009/10, increasing by 2.7 per cent.

Interestingly, larger companies are expected to be hit harder, while financial services bosses are predicting an 8.4 per cent  profit reduction for this year.

But what about all this talk of pay restraint versus inflation?

The report says business leaders plan sharp job cuts in 2008/9, expecting their workforces to contract by 1.1 per cent on average – equivalent to around 350,000 job losses across the economy as a whole.  110,00 jobs are expected to be lost in the finance sector.

But this time round, unlike the 1970s, it thinks the job losses will mean wage inflation will be modest.  “Senior leaders also predict a slowdown in wage increases – falling to 3.9 per cent  in 2008/9 – with no return to last year’s rates predicted during the three years studied,” said a joint communiqué between Hay and cebr.

In a way then the job losses will be a good thing – not that it will feel like that for those afflicted.  If, instead, job losses were more modest, then wage inflation would pick up, interest rates would rise, and a full blown recession, which would be accompanied by many more job losses, would then follow.

In fact, while cebr expects inflation to be well above the Bank of England target of 2 per cent in the short-term, it predicts  consumer price inflation will dip to just 1.75 per cent in two years’ time.

The report predicted growth in GDP will be just 1.7 per cent this year, and 1.4 per cent next.    Capital Economics, by the way, predicts growth of 1 per cent or lower next year.

What cebr and Capital Economics have in common is the belief that 2009 will be worse than this year, that pay inflation will be modest and as a result, in the medium term, the CPI will fall below target.  

Remember, there is a month’s time lag before a change in the rate of interest has its full impact on the economy.  This means that if this report is right, and inflation is due to fall below target in two years’ time, the Bank of E could start cutting rates again in six months’ time.