Evolution works by failure. Evolution works by constantly experimenting, and the experiments that work are repeated, and out of these come both extinctions and population explosions. Evolution has ceased to function in the world of banking because failure is not allowed. Banks may say their service has evolved, but they are not using the word in its correct sense. And as a result their public is the loser.

But the question is this: if evolution had been allowed to work with banks, and in 2008 they had been allowed to fail, what would have emerged in the vacuum that was left? It is actually almost impossible to predict what New Banks version 2.0 would have looked like.

But now, despite the fact that banks required billions of government money in order to survive, we are seeing a new generation of banks evolve anyway.

Today Metro bank opened its doors in Holborn, London. As you know, Tesco and Virgin have plans for a network of High Street banks.

And while this column is a fan of the Internet, we would say that the Net sometimes feels like a force for making things worse. Does anyone like dealing with call centres? And the bigger the Internet brand, the harder the company is to deal with on individual basis. If you are a business with a gripe against Google, you stand no chance whatsoever of getting the company to listen to you. If you are selling a book over Amazon, and are not happy with the service – well, that’s just too bad. But does anything top the banks for making things less personal?

If you are of a certain age, you may recall a TV advert back in the 1980s for Barclays, portraying a nightmarish scene from the future in which some hapless individual battles with robots and computers when all he wants is “to talk to someone”. If you have seen the film Blade Runner, you may get a feel for the atmosphere created in the ad. In fact, it was directed by Ridley Scott – director of Blade Runner. See Barclays Blader Runner ad

It’s all a tad ironic, because these days Barclays is one of the worst offenders. A quarter of a century on and the impersonal world those ads prophesied seems to have come true.

And so it is that Metro will offer a branch service which is open 12 hours a day during the week, from 8am to 6pm on Saturdays, and High Street hours on a Sunday. It will be possible to go the bank and open an account within 20 minutes, have your new card printed on the spot. Local businesses will have a local business adviser who will be able to make decisions. But above all, the bank’s customers will be able to talk to someone, in person, and if they are regular customers, they will be able to talk to people they recognise from previous visits.

In short, a return to old-fashioned banking, with a kind of twenty-first century Captain Mainwaring in the manager’s office, but working longer hours.

There’s a snag. Service costs money.

Apparently none of Metro’s products show up in best buy, top ten tables. The bank does not vary the prices it charges customers according to their risk profile. This of course is precisely what people have been calling out for. But also it does mean, or so David Black From Defaqto has suggested, customers will be turned away from the bank.

And that really is the point. Banks have become impersonal beasts, in which all decisions seem to be made by computer. But this has resulted in cheaper banking. We long for a return to old-fashioned banking that puts the needs of customers first, offers a personal service, but at the same time follows twenty-first century practice in terms of trading hours. But in reality such a service comes at a price, and it remains to be seen whether we are willing to pay for it.

It seems the EU’s banks are in good health. Only a miserly amount of money is required to avoid the reoccurrence of a banking crisis. Hurrah for that.

It is just that bankers, politicians and regulators have just made complete nincompoops of each other.

The author’s local Indian restaurant engenders stress. The menu is so varied, that choosing the right dish can be quite a challenge. Then there’s the local beer festival; how can one possibly know which beer to taste? And finally there are your decent chocolatiers. Selecting the right chocolate – now that is stressful.

But, you know what, maybe none of these three tasks are that bad. Indeed, some may even call them pleasures. It is just that in the great league chart of stress, with moving, giving birth, or sitting final exams near the top, and choosing the right beer near the bottom, the latest stress tests from the EU for its banks are down there with curry, beer and chocolate choosing.

In all, 91 banks were tested. Just seven failed. And everyone had expected these failures anyway. Take the German bank Hypo Real Estate. Now, when this bank sat its SATs back in the bad old days of early 2009, it got a D-minus and was subjected to special needs, meaning it got rescued by the German government. Greece’s ATE bank didn’t fare much better, and sure enough it is still failing. Then there was a quintet of Spanish banks; they failed, too. But the rest are fine. If the roof falls in, the banks will carry on banking as if nothing had happened.

All that the EU has to do is lay its hands on 3.5bn euros to boost the assets at its more troubled banks. Why, it costs more than that to clean up an oil leak.

And if you believe that, we would like to recommend a good book. It is called Gullible’s Travels.

Problem number one, the stress tests assumed a worst case scenario of a 0.2 per cent contraction in the eurozone economy this year and a 0.6 per cent contraction next. They assumed that some government bonds may lose value, but absolutely did not consider the danger of a sovereign default.

Since most EU politicians would say that a sovereign default is not going to happen, one could say their optimism makes sense. It is just that some people, horror of horrors, think their rosy view on the likelihood of default is misplaced, and that Greece, then Spain and Portugal, then Italy and Ireland, and then maybe France, will default, one after the other as workers recoil at the sacrifices they have to make; then will demand exit from the euro, which in turn will push up the value of their government’s debt, when measured in euros, to unsustainable levels.

Problem number two with the stress tests: for banks to pass they must be able to maintain a Tier 1 capital ratio under the conditions of the worst-case scenario defined by its soft examiner. But what counts as assets? If a bank can point to assets in the form of government bonds, and say, ‘See, we are secure,’ and then the bonds crash in value as certain countries default, what use are these assets?

Problem number three: we have been kept in the dark over what makes up the assets of some of the banks in question. So analysts just don’t know how secure the banks in question really are.

Alas, these stress tests are no more than a fairly feeble attempt to prop up market confidence.

It is as if the EU has taken a leaf out of Japan’s book, which dealt with its financial crisis of 20 years ago by pretending the problem wasn’t really that serious. The truth is, there are few things more stressful than cheating in a test and then getting caught.

The snag with banking crises is that hardly anyone understands them. The US electorate know they don’t like banks, but they are not sure what they know about Collateralised Debt Obligations or Credit Default Swaps. And so it is that Barack Obama does what he was elected to do, and much of his electorate ask why isn’t he doing what he promised.

Meanwhile, the Republicans and big business line up against the Act.

The danger of course is that, actually, Barack Obama’s big move will end up solving nothing and creating a whole new set of problems.

Obama said: “Because of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes. There will be no more taxpayer-funded bailouts. Period. If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy. And there will be new rules to make clear that no firm is somehow protected because it is ‘too big to fail,’ so that we don’t have another AIG.”

He said that the Act will ensure “that everyone follows the same set of rules, so that firms compete on price and quality, not tricks and traps.”

But not everyone is impressed. Business Week quoted Mort Zuckerman, who is the chairman of commercial real estate firm Boston Properties (BXP), as describing the Act as “an economic Katrina”.

A few days ago, the Senate Republican leader Mitch McConnell said: “This is a bill that creates a vast new and unaccountable bureaucracy that, if past experience is any guide, will lead to countless burdensome, unintended consequences for individuals and small businesses, that will constrict credit and stifle growth in the middle of the worst economic period in memory.”

The American Bankers Association stated that the Act: “contains a tsunami of new rules and restrictions for traditional banks that had nothing to do with causing the financial crisis in the first place.”

Others say the legislation totally fails to grapple with the issue that really matters, namely Fannie Mae and Freddie Mac, the two mortgage behemoths.

The headline reform relates to something called the Federal Deposit Insurance Corp. This scheme will enable authorities to enforce the liquidation of a failing financial company. The idea behind this is to avoid a repeat of the Lehman Brothers debacle, when authorities were powerless to do anything about the bank’s collapse.

The Act also attempts to enforce regulation to try and avoid the problems of companies which are too big to fail. The biggest criticisms of the Act relate to this portion of the legislation. The argument against this reform says that the size of banks had nothing to do with the financial crisis, rather it was the way the banking system was inter-connected. Investment and Business News goes along with the idea that “too big to fail” is a major problem that needs solving for the simple reason that when firms are too large to be allowed to fail, economic evolution is stymied.

The Act will also introduce regulation that will stop banks from trading in securities that it also advises clients on. It always amazes us how banks can seriously put up an argument in favour of this practice. Proprietary trading in which banks may trade in certain vehicles, sometimes against the customers they are advising, has conflict of interest written all over it. The fact that banks have got away with this for so long is indicative of how much power they yield.

The Act will also pass various regulations ensuring consumers are given more information on the financial products they buy. In this respect, US regulations seem to lag way behind financial regulations in the UK.

You may also recall that one of the most contentious practices of the financial industry is the way it incentivises salespeople to push certain products, irrespective of whether these products make money in the long run. For example, foisting a subprime mortgage onto some poor unsuspecting soul, enjoying a fat commission but then avoiding having to suffer paying any penalty whatsoever when the mortgage finally goes bad. The Obama legislation will go some way to ensuring that the companies that sell securities will suffer some of the downside if the securities fail at a later date.

The Fed will also be charged with taking more responsibility for dealing with systemic risk.

There is no doubt that Obama and the people behind the legislation have their hearts in the right place.

The problem is, it is attempting to deal with horrendously complex problems by enforcing more complexity. As such, the Act is a recipe for confusion.

In the UK, it sometimes feels as if the FSA stymies companies that have good products, and it can create such a wall of bureaucracy that any form of common sense goes right out of the window. For an IFA, for example, navigating financial rules and giving clients good advice at the same time, can feel like wading through treacle.
But at the same time, the FSA altogether misses the issues that really matter. Dodd-Frank could impose a similar strait-jacket of regulation on some US financial firms. In some cases this may prove to be a good thing. But you can be sure it will also suck much that is good out of the system, too.

Last week it was changing the university education system. This week it’s Saint Vince’s favourite whipping boys, the banks.

Apparently overdraft fees are now at a ten-year high. It makes a mockery of low interest rates.

If you sign up to the school of thought that says you can’t fight debt with debt, you will argue that the last thing we need to get out of economic mess caused by debt, is more borrowing. But low interest rates are not just meant to promote cheaper borrowing, they are meant to promote lower borrowing costs for those already in debt. High interest at a time of indebtedness would be disastrous.

Why is it then that credit card and overdraft costs are so high?

The truth is, banks are trying to restore their nasty balance sheets in the best way they can. They are trying to reduce risk, and upping the cost of consumer credit is one way of doing this.

The snag is, by making overdraft and credit costs so crippling, they increase the chances that their customers will default.

Then there’s bank lending to small businesses.

Saint Vince accuses them of not doing enough. Banks say the problem is that small businesses don’t want to borrow.

Mr Cable said: “When we talk about restructuring the banks, what’s going to come out of this is a more competitive system where the customers are not ripped off.

“One of the negative side effects of this crisis is that our banking system that was already very concentrated is now even more concentrated so there’s less competition, less choice and bigger temptation for banks to earn margins at the expense of their customers.”

But, then again, banks were not good at lending to small businesses during the boom. You had a better chance of borrowing money to spend on a jolly abroad then for building up a new business.

One idea floating around is for a kind of new 3i. This is an idea this column has come out in support of previously. Before it was called 3i, the venture capital company was known as the Industrial and Commercial Financial Corporation – surely one of the most unforgettable names in history. It was backed by the Bank of England and private banks, and invested in companies scattered across the land.

The trouble with banks lending to small businesses is that this may be a flawed concept.

It seems bank funding for truly innovatory businesses that could create real wealth is risky. Mr Cable can lecture banks all he wants. But what small businesses really need is better access to capital in exchange for equity. That’s why a new state backed, updated version of Industrial and Commercial Financial Corporation might be a good idea.

Now, this is a bit naughty, but 18 months ago we wrote three articles that we think explain this issue rather well.

Click here for more:

Bring back risk – it’s too risky not to
and, Why risk is skewed against risk takers
and, How Genghis Khan can explain the credit crunch

What has that got to do with anything? Well this toeing and froing seems to be a phenomenon of the economy, too. And in best Chuckle Brothers fashion, the object they are passing back and forth is not very pleasant.

First off it was the US economy with its sub prime woe. “From me, to you,” said Uncle Sam, as the eurozone picked up the debt burden and plunged into debt crisis.

But the last few days have seen the economic poison passed ever more rapidly. Two days ago, doubts that China was going to crash into recession were growing. But the bad news was passed on, and over the weekend talk of a US double dip recession seemed to drown out everything else. What could possibly top that, you might ask? Well, Uncle Sam has had enough already: “From me to you,” he said this morning, and this time we could see a crisis spasm, but in Hungary. Don’t be dismissive of the problem in the making just because it is only little old Hungary. This one has got legs.

But at least one development out of China, or at least a part of China, could change things for the better.

Uncle Sam’s latest double dip warnings

First off, then, what is the latest evidence to point to double dip in the US?

You probably know, a second fall in US house prices seems inevitable. The inventory of unsold stock is so large, and demand so low, that it is difficult to imagine any other outcome.

Last week saw a report from the Council of Economic Advisers indicating that the US government’s $862bn fiscal stimulus package created between 2.5 and 3.6 million jobs. It seems there are two major arguments against creating jobs from fiscal stimulus. The first argument is that such injections of money can crowd out the private sector. A bloated public sector means less innovation and fewer dynamic businesses creating new opportunity. However, while we have some sympathy with this argument when applied to the UK, in the US this criticism may not be valid. After all, this recession has seen not only US unemployment soar, but also productivity. This points to a private sector that is becoming more dynamic, and has plenty of spare capacity. It certainly does not indicate that the public sector is crowding out the private sector.

The second argument against fiscal stimulus relates to what will happen when the stimulus is over. The US government cannot boost the economy via massive borrowing indefinitely. So if an unsustainable fiscal stimulus created around 3 million jobs, presumably an austerity drive like the ones that are being enacted in Europe, and which is surely inevitable for the US eventually, would lead to large-scale job losses.

So that was Exhibit A amongst the most recent evidence pointing towards a US double dip.

Exhibit B is US consumer confidence. There are two key US consumer confidence indices. This column tends to focus on one, the index from the Conference Board. Last week we told how this had fallen sharply in June. But although the drop was severe, all it did was to cancel out the rather impressive rises seen in the previous two months. So the drop needs to be seen in context.

The latest development is from the other index, from the University of Michigan, and we are breaking our normal practice and reporting on it. The index plummeted from 76 to 65.5, and in the process pretty much cancelled out all the rises seen over the last year. In other words, consumer confidence is now at the same level it was at during the recession.

Exhibit C is news on US inflation. Consumer prices fell 0.1 per cent in June. The annual rate was 1.1 per cent. Paul Ashworth, Senior US Economist at Capital Economics said: “With the unemployment rate still above 9% and the recovery showing signs of faltering, the medium-term risk of deflation (meaning the next few years rather than the next 12 months) is even greater than before. The reality is that prices and wages react with a considerable lag to shifts in output and employment. Japan’s deflation didn’t begin until 1994, four years after the collapse in asset prices began. Accordingly, we would caution that the most recent rebound in core prices is no reason to declare victory over deflation. The threat will be with us for a number of years yet.”

Hungary’s resistance to austerity proves futile

Meanwhile in Europe, the IMF and Hungary’s government have had a falling out.

The row is over austerity. The IMF wants Hungary to impose more of it, the government said no. As a result, the IMF has withdrawn the remainder of its lending facility to the country.

Of course, the financial package from Hungary is a joint deal put together by the IMF and the EU. Maybe we are seeing a good cop–bad cop act, with the IMF playing the nasty one. But we know Germany must be grateful. Germans hate the idea of their money being used to bail out countries that are not willing to undergo the pain that they themselves went through under reunification.

The jury is out on the long-term implications of the IMF–Hungary dispute. If Hungary cannot raise the money it needs from this source, then default may be the alternative. If Hungary defaults, other Eastern European countries may follow.

The other side of the jury argues that the fallout will force Hungarian politicians, and maybe more importantly voters across indebted Europe, to face reality.

Our money is on default. It has been argued here many times that the real problem is not debt, it is saving. Globally, we had a savings glut before the credit crunch, and it has not gone away. Default is the inevitable consequence.

Stress tests

Meanwhile, the results of the stress tests of EU banks are being dismissed before they have even been revealed. Well, actually, it seems half the banking world are worried about what the tests will reveal. The other half says they won’t reveal much, and as a result we should ignore them.

Do remember, in the build up to the Iraq war, the US government said Iraq must be hiding weapons of mass destruction from the weapons inspector, otherwise he would have found them.

It is like that with the stress tests. Either they will reveal bad news at the banks, say the cynics, or the tests have been fiddled.

Maybe that’s part of the problem. We are so busy looking for bad news, that it increases the chances of that bad news actually emerging.

Hong Kong reveals minimum wage

It is funny how a measure that for so long has been hailed as socialist policy, is being celebrated by capitalists.

From next year there will be a minimum wage in Hong Kong. From 2011 it will be illegal to pay workers in Hong Kong less than the equivalent of US$4.23 an hour. For a place as maddeningly expensive as Hong, that rate is pretty low. Pity the worker who earns just that amount and has no family to fall back on.

Even so, it is still the latest of several signs pointing to higher wages in China. Earlier in the year the Chinese government revealed plans to get wages up. Since then waves of strikes have led to wage increases.

Don’t be dismissive of the importance of this.

It is popular in the UK to blame the union movement as the cause of Britain’s plight back in the 1970s.

Just recall, economic growth is still a youngster. Until the 1820s GDP per capita had risen at a snail’s pace for millennia. In an innovative economy, demand must rise in tandem with potential, or else the economy is derailed.

In Roman times, economic growth per person was tiny, because the economy was built on slavery and through conquest. The story of the Roman economy is the story of the slowest inflating and then bursting bubble in history.

The Victorian trade union movement may have been the surprising catalyst for the economic miracle of the last 200 years. (That and the development of a banking system based on debt.)

Last night it was revealed that the bank will be forking out $545m as compensation for the disaster that was the subprime portfolio Abacus. RBS lost around $840m from the portfolio and yet is getting only around $100m back from the Goldman compensation.

Meanwhile, it looks like BP may be banned from drilling off US shores for seven years. The legislation, that could be introduced imminently, will deal a nasty blow to the company, which is after all being forced to pay out massive compensation costs related to the oil spill that could potentially be around 60 times greater that the Goldman costs.

Are US authorities being a tad hypocritical?

The first thing you need to bear in mind is that the oil leak was BP’s fault. Conversely, it could be argued, and indeed Goldman Sachs has been making precisely this point, that the Abacus debacle was neither illegal, nor even immoral.

So, the great vampire squid sold derivatives to clients, and at the same time took bets against these funds from Paulson, the huge investment company, without telling other clients. Worse, Paulson was apparently playing an active role in determining what securities made up the funds.

On the face of it that sounds awful, but then again it is quite normal practice. If you have a special reason to think the market has misjudged a certain type of investment vehicle, and so bet against it, it is quite normal to hide your doubts and even try to promote others’ enthusiasm. Banks simply carry out the wishes of their clients.

Goldman Sachs’ defence was firstly that what it was doing is normal, and that its clients were well aware it follows such practices and should have known it was possible other companies were betting against the Abacus securities.

Second, Goldman itself made a loss from Abacus, so it can hardly be accused of deliberately promoting its own self interests.

On the other hand, as arguably the world’s most powerful bank, Goldman Sachs stood centre stage in the subprime disaster. During the senate enquiry into the Abacus funds, Goldman’s representative was at best unhelpful, and at worst downright obtrusive.

Maybe the bank was unlucky. It did what it always does, but on this occasion came badly unstuck. Therefore it is not really guilty at all.

It is just that business is a hard world. The fact is, banks made billions of dollars for years, and yet it appears much of these profits were built on … well, it is difficult to think of a polite word. The one that comes to mind rhymes with ‘full wit’. It is surely not even debatable that banks that are now making profits should channel a big portion of this money into compensating for the economic havoc they wreaked.

After all, without the banking bailouts of 2008/09, orchestrated by the likes of Gordon Brown, would there be any major banks left in the Western world? It is seems possible they would have all tumbled, including the likes of HSBC and the bank of the vampire squid.

“There for the grace of God, go I.” RBS and co. only survived thanks to government money. Others were able to manage without bailouts, but the truth is, the bailouts saved all. The banks that really did stand centre stage are now making huge profits. And then they pay derisory compensation. See Goldman’s compensation costs in the light of the losses that occurred as a result of subprime.

Now we are comparing subprime with the Gulf of Mexico oil spillage. That would be ridiculous. On an economic basis, subprime was much worse.

But the final bill for BP is likely to be around $30bn. Why, it has got 20 big ones sitting in escrow.

This is what an article in the FT had to say about the latest attempt to seal the oil leak: “A mile down and 40 miles out to sea off the coast of Louisiana, a BP-led team has been achieving unprecedented feats of engineering.”

It is the untold story of the oil leak. The efforts made by BP’s engineers have been nothing short of heroic. The FT described what they are trying to do as like “brain surgery in the dark”.

The truth is that when it comes to deep sea oil drilling, BP’s expertise is second to none. And the expertise is truly mind-numbingly amazing.

The PR disaster has been the company’s failure to communicate this.

Did cost cutting lead to the oil spill? Maybe, but so far the case is unproven. A more likely factor is simply that drilling for oil in deep sea is extremely dangerous.

If you really want to look to blame something for the oil spill, blame peak oil and our seemingly unquenchable thirst for black gold. And the US, as the world’s greatest costumer of oil, is more guilty that anyone.

In the UK, petrol isn’t just taxed up to the hilt, it is taxed much further than that. In the US oil is subsidised. Maybe the US government is more guilty than any for the oil spillage because its subsidies, and its refusal to admit to the problem for so long, distorted the market.

Okay, it woke up to the problem a few years ago now. Even George Dubya talked about America’s addiction to oil. But we are paying the cost for the legacy of US energy policy going back decades.

It is possible BP is paying a legacy cost too.

Tony Hayward is the big bad wolf in America right now, but the BP boss hasn’t been in his job long enough to have implemented the changes to safety that some say could have avoided the oil spill disaster. It can take ten years for a complete overhaul of the safety procedures in a company like BP.

Some people in America blame Barack Obama for the US recession. That is absurd. Clearly the cause of the recession occurred before Mr Obama was in the White House. But it is equally absurd to blame Tony Hayward for the oil spill.

Here is the real puzzle. How has BP agreed to park $20bn into escrow without first agreeing it would not be subject to any kind of drilling ban?

All of a sudden talk is that Exxon Mobil will be making a bid for BP. It seems unlikely a merger will go ahead. The US oil giant is busy integrating XTO, the energy company which cost Exxon around $42bn. To try now to buy BP, and then to integrate it, would be a bridge way too far.

But it does appear that beyond it all, there is just a hint of US xenophobia in action. The Toyota debacle smacked of being anti-Japanese, too.

In a way we are seeing US protectionism. It is protectionism by the back door, but it is protectionism just the same.

The French and the Germans want to bring in legislation that will effectively make it harder for US banks to compete in Europe, and they are slated for being protectionist.

But is the US government really being any different?

In other words, for as long as Vince Cable is in a position of authority, plans to separate investment from retail banking will go steaming ahead. You may recall, it all relates to the US Glass-Steagall Act passed during the 1930s depression, which kept investment banking away from the banks where we like to deposit our money. The act was partially repealed under the Bill Clinton presidency, and many have therefore blamed the banking crisis on Mr Clinton. Those who argue against bringing back another act of this nature say that many of the British banks that failed, Northern Rock and HBOS for example, were brought down for reasons that had nothing to do with investment banking. Therefore, by focusing on a new Glass-Steagall, policy makers are wasting their time on an irrelevance when they should be busy doing more important things, and in any case the high profits that come with investment banking could enable the sector to recover.

Despite the halo that sits above his head, Vince Cable is not always right, but on this occasion he is, and he is right for a reason that critics overlook. Evolution needs failure. It is like that in nature, and it is like that with the economy. Failure purges an eco system, or an economy, of bad ideas, and makes room for the right ideas to grow into it. When banks are so big that governments dare not let them fail, evolution cannot work its magic. We all know there’s much that’s wrong with banks. They may take far too big risks with their investment banking, but when it comes to backing entrepreneurs, they take on the persona of Scrooge. And as for the lack of human contact, is there anyone who likes the communication channels we now have with banks, and the way decisions seem to be made by computer. Beware of wishing for the olden days. Our view of what it used to be like often has a rose-tinted gloss, but on this occasion, the days of the bank manager who really tried to understand business and could make decisions are sorely missed. Maybe if banks were not too big to fail, evolution would by now have thrown in more of the banks that we really want.

That’s the problem with hanging on to failing businesses; evolution is left impotent, and the economy becomes stagnant. This is precisely what happened in Japan, of course. At least it is if you listen to some experts. Alan Greenspan has always maintained this. He once recommended to Japanese authorities that they should let businesses fail, to which he was told that he was right, and had diagnosed Japan’s problems perfectly, but it “was not the Japanese way”.

But alas, the Japanese way may not be so pretty. At least, if you listen to the words spoken by the new Japanese PM, Japan’s way may be in the same direction Greece is going. Still, at least in China a new save of social unrest could be good for the economy.

See Is Japan set to go way of Greece, and why China should be celebrating outbreak of British disease

The European Central Bank is supposed to sit centre stage in European banking. Alas, it now seems to be at the hub of the latest crisis.

On Monday it rattled markets, warning that the banks of the Eurozone may yet be forced to make write-downs of around 195 billion euros. All of a sudden, Goody Two-shoes Spain has joined the naughty list. Its government has already been forced to rescue one bank. Spain was supposed to be immune from a banking crisis because its regulators required its banks to apply higher capital ratios. For that matter, last decade Spain was one of the stars of government borrowing, with much lower net debt than most other economies. It even enjoyed occasional fiscal surpluses. Oh, how quickly that has changed.

It just goes to show, regulation does not hold the answer.

But now, happy memories from 2008 come back as banks decide they can’t trust each other. Yesterday, the value of cash deposited with the European Central Bank’s overnight facility hit an all-time high. Banks, it appears, would rather lend to the ultra-safe ECB for a lousy interest rate than to each other.

It is difficult to look through this and know whether banks are creating problems for themselves by being so unwilling to lend to each other, or whether in fact there is something more serious. Was the banking crisis of 2008/09 caused because banks stopped trusting each other, or was it caused because US sub-prime borrowers had run up debts they could not possibly pay back? Had banks got together and decided to carry on lending to each other come what may, would Northern Rock and Lehman and RBS and HBOS still be going concerns, with zero state ownership? Or maybe interbank lending was the problem, and the banking sector had been propped up by wings and prayers for far too long and nothing could have been done to avoid the crisis.

Talking of crisis, Lajos Kosa has really gone along and done it. He is the vice president of Hungary’s ruling Fidesz party, which recently won the country’s election. Before the election, his party were making all sorts of promises about tax cuts, and said little about the austerity drive in the pipeline (sounds familiar). Now that the new party is ruling the Hungarian roost, it seems all kinds of skeletons have been found in the cupboard (sounds even more familiar). Mr Kosa has said that the chances of Hungary avoiding a Greek-style crisis are “very slim”. He has also said that the country’s fiscal debt is likely to be around 7 to 7.5 per cent of GDP this year, almost twice the level the previous government had predicted. In other words, it is not the new government’s fault, and it had absolutely no way of knowing this before the election, but it seems Hungary is in for much tougher cuts than anyone had previously said (sounds very familiar).

Hungary, along with much of emerging Europe, including the Baltics, faces Greek-type crisis one degree removed. Right now, the problem in Greece is the euro. She needs a cheaper currency. But she is stuck with the Euro.

Hungary and the rest of the gang are not similarly handicapped.

But should Greece have its own currency, which then falls, the value of her debt, which is held in euros, would escalate, and default would then appear to be inevitable.

Hungary dare not let its currency fall by too much, because then its debt would become too burdensome. Either that, or she would default.

So you see, the chances of defaulting across Europe are mounting. That’s why banks are running scared of each other.

It is not pretty.

Globally we have a problem that some countries and some sectors are saving too much, while others are borrowing too much. Demand must match supply or we get recession. For years, recession was avoided because savers’ money was being lent to others who propped up growth via their borrowing. This is no longer sustainable.

Either we get a situation in which we all become savers, or debt repayers, which may cause global depression. Or wealth is redistributed from savers to debtors to avoid default. Neither is pretty, but common sense might say the latter course is the preferred option.

This is what Mark Froeba, a former derivatives unit vice president at credit rating agency Moody’s, told the Financial Crisis Inquiry Commission: “Essentially, they used intimidation to create a docile population of analysts afraid to upset investment bankers and ready to cooperate to the maximum extent possible.”

Eric Kolchinsky, another former bigwig at Moody’s, said: “Concern about credit quality took a back seat to market share…While there was never any explicit directive to lower credit standards, every missed deal had to be explained and defended. Management also went out of its way to placate bankers and issuers.” He added: “The focus on market share inevitably led to an inability to say ‘no’ to transactions. It was well understood that if one rating agency said no, then the banker could easily take their business to another.”

You may need to be American, and perhaps of a certain generation to get the next question. The panel’s chairman Phil Angelides asked Mr Kolchinsky whether it was like that scene from ‘Ask Lucy’ when the title character has to pack chocolates from a speeding conveyer belt. He replied: “Oh yes, all the time.”

The ‘bubble-ette’

Also speaking at the hearing was our Warren. The world’s third richest man has quite a way with words, he just says it as it is. He said: “The entire American public, eventually, was caught up in a belief that housing prices could not fall dramatically, and Freddie Mac believed it, Fannie Mae believed it, Congress believed it, the media believed it, I believed it.”

“But aren’t credit ratings expected to act like referrers and make the right call, even if they get booed?” asked one member of the panel. “Yeah, and they made the wrong call,” replied Buffett. He said: “the Cassandras were there, but who was going to listen to John Paulson in 2005 or 2006…it didn’t mean anything…look at me, I was drawn on it too. I recognised that something pretty dramatic was going on in housing, but I actually called it, in the annual meeting.. a ‘bubble-ette.’ Well that was a terrible term to use. It was a four star bubble.”

To put it all another way, Mr B says don’t be too harsh on the credit rating agencies. It is too easy to be wise in hindsight.

The burnt barbecue

Meanwhile, yesterday, the European Commission revealed its own plans to deal with credit rating agencies. First off, it may fine them. Secondly, it is mooting the idea of setting up its own state owned agency.

So that’s a good idea. No doubt a state owned credit rating agency will be super efficient, will never impose massive burdens of bureaucracy, and will always spot the crisis in the making. Never mind the fact that no two crises are alike, and as often as not the measures we put in place to ensure we don’t get a repeat of one crisis, can actually create the next one. Let’s hope we don’t end up with the economic equivalent of food poisoning as a result.

And so Paddy Ashdown reckons David Milliband wasn’t even interested in a deal with the Lib Dems. According to press reports this weekend, while poor old Gordon was up for a Lib–Lab pact, it was young Mr Milliband who put the kybosh on the idea. Can’t think why.

David Hall said on Australian TV: “I saw the Governor of the Bank of England last week when I was in London, and he told me whoever wins this election will be out of power for a whole generation because of how tough the fiscal austerity will have to be.” See The poisoned chalice, the 6p hike in income tax, and the way out of trouble

Whoops, sorry about that. Not sure how that previous paragraph appeared there. Reports that Labour were apparently disinterested in working with the Liberal Democrats, and this idea that whoever runs the country for the next few years will be so damned by the economic problems that they won’t get re-elected for a generation, are quite clearly unrelated.

Sarkozy loses his head with Angela – and why the UK is heading for gooseberry status

Nearly headless Nick Sarkozy shouting and bawling? Surely not. Well, according to a report in a Spanish newspaper, that’s precisely what he was doing, and his venom was aimed at Angela Merkel. According to El País: “It was Sarkozy on steroids…He’s always very energetic. This time he was very emotional, too.”

So why so cross?

It seems the French leader was furious with Germany over its reluctance to provide money to back the EU’s trillion dollar bailout package. Apparently he even talked about France leaving the EU.
Mind you, Angela seems to be a tad concerned that the euro does not disintegrate. She recently told Germany’s parliament: “This is about nothing less than the future of Europe… and with it the future of Germany in Europe.”

Writing in today’s Telegraph (17 May) Roger Bootle said: “I am more confident that the coalition [Lib–Conservative government] will endure than I am that the euro will hold together.”

You see, at the moment the Brits are enjoying generous helpings of schadenfreude, watching the Germans and the French rowing about something most Brits thought was a bad idea from day one. And yet, the two rowing parties have something in common. They both think the euro’s survival is essential, and that the EU itself could fall apart without the currency. They may or may not be right. But let’s assume for the sake of argument that they are right, and that without the euro there is no EU.

There is one overriding important justification for the EU, which in the UK we keep forgetting. Above all else, the EU is meant to be a solid, cast iron block to any future war in Europe. It is meant to solidify relations between France and Germany so much that never again will the two resort to tanks, guns and missiles to settle their differences. In the UK there is still this feeling of superiority, because ‘we won the war’ and with the exception of the Channel Islands no part of Great Britain fell under German rule during the war. And it is the wartime experience which defines the relationship between Europe’s three biggest economies.

But to French and German minds, there is a justification for the euro which transcends economics. To them it is all about reinforcing the barrier to there ever being a European war again. And so they make sacrifices and throw money at a currency, which from an economics point of view may be a bad idea.

Presumably there is a good chance that France and Germany will work their way through this. It may take two or three years, or even longer, but before the end of this decade we may see even closer links between Germany, France and the rest of the surviving euro gang.

For very sensible economics reasons, the UK has kept out of it. And along the way we have had a jolly good laugh at the state of French–German relations. But then in a few years’ time, assuming the euro still exists, the UK will look like it’s more of an outsider than ever: the country that sat back and enjoyed the advantages of an independent currency, and as a result enjoyed a free ride on the back of the Eurozone’s troubles.

In the light of the above, now consider these words recently uttered by the French equivalent of Lord Adair Turner, Jean-Pierre Jouyet who heads France’s financial watchdog. He said: “The English are very certainly going to be targeted given the political difficulties they have. Help yourself and heaven will help you…If you don’t want to show solidarity to the Eurozone, then let’s see what happens to the United Kingdom. You have Europe of the euro, Europe of the countries that understand the euro…and you have the English.”

Watch my lips. No plan to raise VAT, and yet deficit worse than expected

Hands up all those who thought the UK’s burgeoning fiscal debt crisis was worse than we had been told. And if you thought politicians weren’t being strictly honest with us during the election campaign, than keep your hands raised. So let’s take a look. Well, surprise, surprise, that’s just about all of you. Alas, it seems our new chancellor Boy George counts amongst those who sit in the surprised camp. He must do, because apparently the UK’s debt is much worse than we had been told. “We are finding all sorts of skeletons in various cupboards and all sorts of decisions taken at the last minute,” said the new man at Number 11. “By the end, the previous government was totally irresponsible and has left this country with absolutely terrible public finance,” he said, barely able to hide his alarm. In fact, he told the News of the World: “What a mess they’ve left behind”, while David Willetts, the new Business Secretary was quoted in The Telegraph as saying he has been left “not so much an in-tray as a minefield”. The Sunday Times quoted Vince Cable saying: “I fear that a lot of bad news about the public finances has been hidden and stored up for the new government. The skeletons are starting to fall out of the cupboard.”
Osborne’s cunning plan is to set up a new Office for Budget Responsibility, to be headed by former economic adviser to the Treasury Sir Alan Budd.

You see, no doubt this new body will find all sorts of problems the government could not possibly have anticipated, and because they have been found by an independent body, one assumes the figures will have more credibility. It won’t be the new government’s fault, because they couldn’t possibly have guessed, but it seems tax rises or spending cuts are going to have to be more severe than we were told during the election campaign. That’s strange, why are everyone’s hands still up?

Greece looks to sue bankers – and the bank that cannot be named –
Goldman you know who

Here’s an idea for Greece. Stop contemplating the national navel and, instead of accepting things have to change, sue the banks instead.

Asked on CNN whether Greece may resort to legal action against certain banks, the Greek leader George Papandreou said: “I wouldn’t rule out that this may be a recourse…Greece will look into the past and see how things went…There are similar investigations going on in other countries and in the United States. This is where I think, yes, the financial sector, I hear the words fraud and lack of transparency. So yes, yes, there is great responsibility here.”

And so what does all this mean? Well, let’s see, it’s called ‘blame Goldman Sachs’, and for once, if Greece wanted to enlist support from the US, she would be pushing against an open door.