Saturday, 4 February 2012

Robin Hood, the Prime Minister

Income redistribution in the Middle Ages was a clearer affair than nowadays. The rulers at that time did not have VAT, duties, income and capital taxes as well as social assistance programmes to play with. It was plain and simple: let’s build another cathedral, paid-for by the king and the local wealthy lords. As the sponsors owned most meaningful and  income-producing assets, after a few generations most of the wealth redistributed to the people who worked for years at the spiritual infrastructure of the day was back in the iron boxes down in the chateau’s dungeons. Such an ineffective system created the demand for informal distribution via entrepreneurial outlaws who became the stuff of legends. As most fictional characters, the Robin Hoods in most cultures that have them were brave, competent and just. Always. Taking from the rich and giving to the poor was their business and, had that the masses at that time had the right to vote, merry men across Europe would have gotten a one-way ticket to the top.
We live now in times that, sometimes, resemble the Middle Ages. The crisis we are now navigating started, as most crises do, with an asset bubble, real estate this time. It then became a credit crisis and now, finally (?) reached the major issue of the developed world, unsustainable sovereign indebtedness. 
Owning your home, paying for it with a long term mortgage that the government partially guaranteed became a norm that sustained prosperity but also was an effective tool for social “control”, fundamented primarily by Roosevelt’s New Deal. Conditioning regulatory approval of bank mergers with set targets for mortgage lending for lower income families in one of the world’s most fragmented banking markets set for consolidation, as Carter did, played a major role in setting the demand for what was much later called sub-prime lending. Financial deregulation, lax monetary policy and dumb bankers fuelled the seemingly endless supply of cheap money. Greed, the overwhelming greed  of the consumer, politician and banker did the rest.
Financial panic caused by banking collapses, particularly Lehman Brothers, switched-off the credit markets.  Both households and corporates started the largest mass de-leveraging process ever witnessed. Large companies have now unusually cash-rich balance sheets; Apple’s cash reserves now stand at just under $100bn, although two thirds of it is trapped in foreign subsidiaries.
The credit crunch and overall deleveraging moved the spotlight to some of the world’s worst borrowers, some European governments. Widely leveraged balance sheets, large and hardly to adjust social entitlements, decreasing competitively and bad demographics showed the hollow body behind the now gone AAA ratings. Sovereign debt of wealthy countries that cannot grow their economies is by far the largest threat to the Western economies and the global financial system.
Human nature made us the voters and homeowners that borrowed like there is no tomorrow, decide that we could not possibly have played any role in this mess. Politicians, whose fundamental profession requires short term posturing and medium to long-term dishonesty and inconsistence, also decided that there was no responsibility on their side and that the blame lays, fair and square, with the bankers. That’s a), dishonesty. The solution to the crisis, according to most bureaucrats, is more regulation and more capital, which are the key blocks in banks expanding their balance sheets, i.e. lending more, which is the chief requirement from politicians across the spectrum. That’s b), inconsistency. Banker bashing became popular a couple of years ago and it continues to be, on both sides of the Atlantic. It is has re-focussed on the financial profession, particularly now that banks announce results and bonuses, but it has expanded a bit to the rich, the wealthy, the 1%, whatever you want to call them. That’s c), posturing.
Financiers are a popular target as they are fairly visible as a profession in the top 1% earners. In the US, while the share of lawyers and doctors in that group stayed constant at 8% and 16% respectively since 1979, financiers have increased to just under 14%, up from 8% in 1979, although somehow in line with the increase of the overall financial services sector. Roughly a quarter of the income earned by the top 1% come from dividends and capital gains that are taxed differently. Such incomes are heavily affected by economic crises, hence the share of 1% in the overall US income fell from 23.5% in 2007 to 17.6% in 2009.
This is another topic of debate and most rational people would probably agree that wealth concentration to very, very few while the very, very many struggle, is a recipe for social trouble in democracies as well as in dictatorships. What is concerning is that the current rhetoric is exceptionally populist, goes in many ways contrary to the interest of the society and appeals to most basic instincts of people.
In the “Land of the Free”, the quintessential business-friendly country that is the US – remember “the business of the US government is business” –  success seems to be now frowned upon. Mitt Romney, the front-runner Republican nomination candidate, has been constantly attacked for his successful career as a senior private equity executive with Bain Capital. The issue of his tax returns became a central debating point, something that he himself seemed to be ashamed of. The fact that he paid a 13.9% effective tax rate on his $42m income over the last two fiscal years  is a reflection of the legal tax rate on capital gains, not of him parking money in an anonymous Swiss bank account. Vicious attacks came from within the Republican party, particularly from his political opponent New Gingrich, who has attacked the whole institution of private equity as being job destroying, very much alongside the “leeches” comment made a few years ago by a German social democrat politician. Three comments on this. i) When taking into account a two years post-investment period, private equity owned business in the US lose on average 1% of their workforce; considering they tend to invest in underperforming businesses that does not seem that bad. ii) Job creation is the result of positive economic activity; it may reflect sometimes specific government policies, but it is not what private equity firms are supposed to do; as the Head of Bain Capital said at Davos, private equity is supposed to create good companies, not jobs. iii) Mr Gingrich is a career politician, a former Speaker of the House that at some point was a consultant of Freddie Mac and Fanny Mae, the US mortgage giants that needed enormous taxpayer bailouts; he is remembered as the driving force behind Bill Clinton’s impeachment for lying about the Monica Lewinski affair, while having himself an affair with an intern in her early 20ies.  In the US, the politics of wealth seems to be moving away from an analysis of effective and rational measures, such as revisions of the exceptionally complex tax code, and hard to sustain unsustainable and moving towards class warfare rhetoric.
In the UK, one of the Labour Government’s latest acts in power was to increase the top tax rate paid by the wealthier parts of the population to 50%, part of a wider populist discourse in the run-up to the elections. They estimated that about 300,000 people would have to pay that on income exceeding 150,000 pounds per year. This was less that 1% of the overall UK voting population and most of them were anyway non-Labour voters. On the other way, it was a very popular measure, presented to people and consumed by a lot of them as the panacea to UK’s heavy public debt load and the way for a fair society. The voices of economists saying that it would raise relatively insignificant amounts of tax while acting as a deterrent for highly mobile wealthy people and that overall, the UK may even lose tax money, were swamped in populist cheers by politicians as well as simple people. The additional tax intake is indeed limited, particularly given the greatly diminished number of bankers in the City. Some exceptionally wealthy individuals and businesses have moved, mostly to Switzerland, and took their income tax, council tax, VAT, etc with them. London is now the heaviest taxed financial centre in the world, well above Paris, Tokyo, Zurich, New York or Hong Kong. The anti-bonus backlash has pushed banks into finding alternative pay structures, which offer benefits over a longer time period, and much, much less cash now; while that may be a positive incentive structure, it does mean much less tax now.
If you think that banker bashing has now toned down, you would be mistaken. Stephen Hester, a well respected banker, was brought by the Labour government in 2009 to run RBS, the bank owned 82% by the government. His restructuring plan was considered very good and was approved. Among other things, the plan detailed a renewed focus for RBS’s investment banking business, however subsequent government regulation and capital requirements among other things made that impossible and this business is now closing.  In spite of a difficult business environment, hostile public as well as continuously shifting and uncertain regulatory background, Mr Hester did a good job. Everybody seemed to agree including RBS’s Board that awarded him a  one million pounds bonus in shares that vest in three years from now. This bonus is still half of what he could have been entitled under the terms of his 2009 contract. The choir of outraged politicians was deafening, all of them were outraged, particularly the Labour party that appointed him. All the merry men of UK politics were up in arms against the fat cats getting richer. Mr Hester became Public Enemy #1 in the eyes of politicians and public and was essentially forced to give up his bonus. This was a sad moment, a clear indication when politicians have interfered in running a bank. The long-term impact of this situation on RBS’s value (i.e. the government’s stake) is hard to quantify.
Francois Hollande, the front running candidate for the French presidency, has identified the bankers and the financial sector as the real enemies he will have to fight. He will make sure that as much money is taken from these wealthy people as possible, as he will have to pay for tens of thousands of state-sponsored jobs for young people and hundreds of thousands of additional public service workers that he committed to create. And, he will also have to pay for the revised retirement age, which should go down to 60. Yes, this is XXIst century!
So, Robin Hood seems to be the ticket the Western politicians decided to run on. How awful it will be for them to behave, once in power, like the Sherriff of Nottingham. 

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