Vericool Finance

Angry Shareholders

There is a distinct whiff of cordite in the air.  Investors at this year’s AGMs have been expressing rage at the wholesale destruction of value.  Eggs were thrown at the directors of Allied Irish Bank; protestors singing the Marseillaise stormed the stage at Belgian bank Fortis; and there have been confrontations over pay at BP, Provident Financial and Amec.

This has been the biggest backlash yet.  In one of the most significant investor rebellions in years, 59% of Royal Dutch Shell shareholders voted to reject the company’s executive pay plan – evidence of the mounting anger over remuneration and bonuses.

Shell had it coming:  the behaviour of the non-executive directors on the company’s remuneration committee was outrageous.  According to their own rules, bonuses would be due if Shell came third or better in a league of five oil majors ranked by total shareholder return.  When the company finished fourth, directors brazenly declared that the race was so close that fourth was as good as third. Shell moved the goalposts.  But there are plenty of other cases where the goalposts were simply set in the wrong place, with shareholders’ approval, making it ridiculously easy for executives to claim huge payouts for mediocre performances.

That fact, one suspects, partly explains the sudden outbreak of rebellion.  Investors are finally realising that the wool has been pulled over their eyes for years. Stock markets are back where they were a decade ago, dividends are being slashed, but boardroom pay has gone to the moon.

In boardrooms, in clubs – and at certain flower shows one might mention – you will hear much huffing and puffing from some directors about having their hands tied.  Others will feel they can shrug off shareholder votes, which are non-binding, even when they’re made on the scale we saw at Shell.  But Shell’s remuneration committee, led by Sir Peter Job, has taken shareholders for granted for the last time.

Other directors take note:  next time, the protest could get personal. If that is what it takes to remind self-interested executives who really owns their firms, so be it.  The crunch has highlighted a crisis of ownership.

Supine institutional shareholders, such as pension funds, were the handmaidens of recklessness, greed, corruption and destruction- and they allowed it to happen with our money.  Regulation is only part of the answer:  we need to move from a culture of entitlement to a culture of responsible ownership.  Executives, like politicians, must be forced to realise that they work for us.

Are Hopes Of Recovery Over-Done?

They say you know the tide has turned when the last great pessimist throws in the towel.  So there was some significance in George Soros’s recent pronouncement that apocalypse has been avoided. “The economic freefall has been stopped, the collapse of the financial system averted,” said the billionaire investor whose graphic warnings of imminent doom shocked the world last year.

And all around, it seems, there is optimism that the worst of the slump may be behind us.  Commodity prices are rising, indicating that global manufacturing demand may be picking up; investors seem willing to stump up cash for banks and companies; even the OECD now indicates that a sharp bounce in April activity suggests that the best-case scenario – a V-shaped recession – is no longer out of the questions.

But, there’s a big difference between an economy getting worse more slowly and one that is on the path to recovery. Even if modest signs of improvement develop into rising output by the autumn, there is still a strong risk of relapse into a double-dip recession. The bank of England recognises as much:  its move to step up quantitative easing with an extra £50bn shows it believes the banking system remains fragile. And unemployment, up by almost 250,000 in Q1 (the biggest quarterly rise since 1981), still looks worrying.

We can’t assume the international outlook is altogether rosy either.  It would take a sustained rise in Chinese exports to suggest that demand in the rest of the worlds has turned, yet they fell by 3.5% between March and April.  And US property prices are still falling, while losses at Wall Street banks continue to mount. As Gordon Brown never tires of telling us, this crisis began across the pond.  And that’s where it will end.

Green shoots have been proliferating in the hothouse of the financial markets, but step outside and the climate is very differen.  Bank governor Mervyn King’s withering summary of conditions suggests an economy that, rather than shooting, looks shot.  Recovery won’t begin until 2010, King said, and even then there are pretty solid reasons for questioning if that will be sustained.

The coming years will certainly be rough, yet the nation today is markedly different from the shabby, defeated country we were in the 1970s.  Britain, in fact, seems determinedly cheerful.  Why?  Perhaps because, although things are bad, no other country seems to be doing markedly better; or perhaps because – having dug ourselves out of a hole once before – we feel we can do it again.

Spring Fever

Swine flu, a major bankruptcy, rumours of big holes in US bank balance sheets… last week looked like “yet another shocker” to add to all the others that have roiled the financial system.

Not so long ago, any one of these events would have wiped billions off stock markets; together they would have caused catastrophe. But something has changes.  Traders seem bent on shrugging off the bad news and continuing a winning streak that has lasted almost two months. As Richard Dunbar of Scottish Widows observed on the BBC Radio 4 Today programme, “the market has moved from 100% fear to 100% greed” in six weeks flat.

This feels like a pivotal moment in 2009’s titanic battle between bulls and bears, and the bulls would appear to be in the ascendancy.  Equity markets across the developed world have jumped by a third; emerging stocks are on fire; and risk indicators are retreating.  Three-month Libor (the inter-bank lending rate) dropped below 1% this week, reflecting banks’ willingness to trust each other again.

Meanwhile the big guns are out in force, reiterating their conviction that the good times are rolling again.  Hedge fund manager Crispin Odey, who made a fortune shorting bank shares on their way down, has reportedly made another mint after buying them at the bottom, and he’s convinced the rally has only just begun.

Investors, like policy-makers, are betting that optimism will prove self-fulfilling. Clouds become mere appendages to big silver linings. As for unequivocally bad news – a huge increase, or confirmation that UK house prices are still falling – it is simply ignored.  Investors seem to be on a mood-enhancing drug.  And, in a sense, they are.  Governments and central banks have been issuing vast quantities of a stimulant (cheap money) that gets markets high.  But the drug is still in trials, and may yet have adverse side-effects.  Try soaring inflation, for starters.

There’s now a risk of a massive trap for unwary investors. Having preserved their money after the first big crash, they are now being set up to lose it in the next one. The economy is still in deep trouble and markets cannot ignore that fact forever. The most that can be said at this point is that financial Armageddon is no longer looming. If that’s true, it may well be worth 20% on share prices, but is can’t create a sustained bull market.  For that to happen, more good news is required.  Recoveries in the real economy tend to require something more substantial than a handful of semi-cheery surveys.

How Broke Is Britain?

It is considered a golden rule in politics that Budgets that look good on the day, start to look poor by the weekend and vice versa.  Last week’s Budget broke that rule.  Even the dreadful borrowing figures announced by the Chancellor of the Exchequer last week – pushing the national debt well beyond £1trn – were not dreadful enough to describe the reality, as became clear within days, when a set of shocking GDP figures recorded a contraction far worse than expected. Over half a trillion pounds of borrowing is scheduled over the next few years.

It could easily be more. On the Government’s own forecasts, the public finances will come nowhere near balance until 2018.  Some experts reckon we’re looking well into the 2030s or the 2050s.  “In the long run”, Keynes famously said, “we are all dead”.  But this is getting ridiculous.

The Chancellor has admitted the Government needs to borrow £220bn in the gilts market this year, just to keep finances afloat.  After that, he claims, things will start to get easier.  Really?  Darling’s expectation that the economy will shrink by “only”3.5% this year already looks out of date.  But this wildly hopeful assumption that this decline will somehow reverse into a growth rate of 3.5% in two years’ time seems preposterous.

Using the IMF’s more neutral economic forecasts, Monument Securities reckons Britain will have to tap gilt buyers for some £230-235bn this year and about the same in 2010/11.  At the moment, the Government is having little trouble finding lenders:  the increased supply of gilts is being soaked up by the Bank of England’s £75bn quantitative easing programme and by foreign buyers.  But if investors begin to doubt the Government’s ability to close the deficit, the market’s willingness to refinance sovereign debt could come to a sudden halt.  Epithets of “banana republic” and “sick man of Europe” may yet return to haunt the British.

Britain does have one advantage.  It entered the recession with relatively low levels of public indebtedness compared to other countries.  This means that, even with a dramatic surge in liabilities, it will end up with only a middling level of debt compared with G7 countries overall.  Yet we shouldn’t take refuge in that.  On some measures, Britain’s public finances are now the worst of any rich country: next year, we will probably have a bigger deficit, as a percentage of GDP, than the like of Italy.

Retaining market confidence calls for plausibility and willingness to forego overly optimistic forecasts.  The only way out is to confront the problem head on.  This dishonest Budget has done Britain no favours at all.

Darling’s Recession Budget

You’ve got to hand it to Alistair Darling.  Only this most emollient of politicians could manage to make this Budget seem boring.  Yet the content of the speech was, in many ways, explosive.  He told the country that British prosperity was, in important respects, as fraudulent as collateralised debt obligation; that the boasts of ‘no more Tory boom and bust’ are a joke; that the economic forecasts he gave only last November were nonsense, and the public finances are deteriorating at a rate never seen before in peacetime.  And all with a deadpan face.

Darling announced a rash of measure to steer Britain towards recovery, but the Chancellor’s efforts to offer a little to everyone failed to find approval in most quarters.  Indeed, he faced a chorus of disappointment.

Apart from the sheer mess of the economy, the big problem facing Darling was that hopes were perversely high.  This was one of the most anticipated Budgets in decades, with commentators on both the left and right urging dramatic action.  Be bold Chancellor, you could be our next Lloyd George,” said Polly Toynbee in The Guardian.  “Give voters a rock-solid reminder of what Labour is for”.  The Times was equally convinced that that Chancellor should follow the advice of President Obama’s chief to staff, Rahm Emanuel, and not let “a serious crisis to go to waste”.

With the weight of the public finances endangering the nation’s prospects for recovery, the Budget presented a perfect opportunity for ministers to change course away from ever-rising public expenditure and to profoundly change the shape of the government.  In the event, the Chancellor did announce a cut in public service spending growth:  it will fall from 1.1%, to 0.7% in 2001-12.  He also announced £15bn in “efficiency savings”.  But this is a little more than tinkering around the edges, £15bn over five years represents only a fraction of Britain’s annual interest payments on its public debt.  Far more profound changes are needed in a public sector that has grown out of all proportions to Britain’s ability to pay.

Darling’s Budget task was daunting enough to evoke pity. He had to reassure investors that Britain isn’t going bust, but to do so without taking too much money from the beleaguered taxpayer, or out of and economy in deep recession.  His response was a flight into fantasy. There was no bust Britain, he seemed to say, only a temporarily tripped-up Britain, which would soon be swanning along again.  He offered no meaningful explanation of how the deficit would be shrunk.  He acted like a fantasist – presenting the terrible news and pretending it didn’t matter.  Britain’s black hole required an adult response.  We didn’t get it.

The Knackered Celtic Tiger

“People didn’t want to deal with it while the party was in full-swing, but now the music has stopped.  We’ve lost a fortune,” observed U2’s guitarist, The Edge, in a trenchant piece of economic commentary.  He’s not the only one mourning the dead Celtic Tiger.  Ireland’s descent into the financial maelstrom – after more than a decade as, ostensibly, Europe’s most successful economy – has hit the country for six.

Economic activity appears to have ground to a halt:  a new McDonald’s outlet in the west of the country is said to have been “inundated with job applicants”, including bankers, accountants and architects.  Amid growing public anger, the government finally bowed to the inevitable and announced an emergency Budget.  The country is now steeling itself for “savage” cuts in public spending and hefty tax rises.

With growth predicted to plummet by 8% this year and a budget deficit of 18bn Euros, Ireland’s finance minister, Brian Lenihan, had little room for manoeuvre.  Without these tough measures, Ireland’s fiscal deficit could have reached 13% of GDP this year – more than four times the EU limit.  Even so, he may have pulled the wrong levers.  Lenihan sees the future of the Irish economy in exports. Yet, as a member of the eurozone, Ireland can hardly devalue its currency to stimulate demand.
Moreover, by pulling this hard on the tax lever, Ireland may only succeed in exporting its best hope of recovery:  its talent.

There’s also a risk that by tightening public spending, Lenihan will trigger a further downward spiral in property prices and bank solvency. Credit rating agencies are already casting doubt on the survival chances of Ireland’s biggest banks.  Britain is not there yet, but the similarities between our banking and property-dependent economics are striking.  Given a few more failed government debt auctions, this could be the future that awaits us.

Ireland’s short, sharp shock approach to putting its finances in order may, in fact, be preferable to the long, slow march back to fiscal rectitude that Britain faces once the crisis is over.  But don’t expect Alistair Darling to follow Lenihan’s lead next week: The British Government is far too wedded to its policy of fiscal stimulus.  Yet, given the black hole in our accounts, the main question at the heart of the Budget is surely “how close the nation is to bankruptcy”.  The Government’s accumulated losses may yet send Britain into the IMF’s embrace.  To hear Lord Mandelson saying there should be no ‘stigma’ in taking a begging bowl to the fund is to know how delicately balanced the public finances truly are.