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. 

Natural gas, markets, politics and other bores

After the WWII,  US made a major commitment to natural gas as a source of energy. From a very small and local business (i.e. no long-distance pipe network), natural gas became a major energy source covering 25% of the US energy demand by the beginning of the 1970’ies. By that time, gas companies built an intricate network of pipes connecting high demand urban sprawls to remote gas fields. This economic and engineering development had not been matched by a similarly progressive policy, and the gas prices stayed highly regulated. As always, this means low prices to keep voters happy, but set arbitrarily and in a complex way. Politicians have generally shied away from the difficult task of convincing their voters to trade today’s low prices for a much larger but less clear multi-generational benefit. Economics suggests this is a disastrous choice that it discourages long-term investment, ultimately leading to supply constraints. As bad things come, such a bottleneck came in the exceptionally cold winter of ’76-77 and brought large scale industrial shut downs, closing of schools and major disruptions to other public services . Even the politicians found such a disaster hard to ignore and started the exceptionally difficult process of liberalising the prices, a process finalised with the Natural Gas Policy Act of 1978. Deregularisation brought predictability to a large and growing market, which in turn attracted the large, long-term investments required; gas supply never became a problem in the US, while overall reserves were fairly continuously augmented by new discoveries. Prices dropped and kept voters and businessmen alike content – there was even talk of a gas bubble at some point. The so-called bubble (oversupply) was, as it is in most cases, linked at least partially to the half-measures produced by the US legislators. Price deregulation did not mean full market liberalisation; politicians decided to ban the use of natural gas in the production of electricity as this was too valuable to just be burned away, so a growing economy resorted mainly to coal to satisfy its power needs, leaving natural gas mainly for domestic and industrial consumption. One can speculate on the long-term impact on the environment.

When this ban was removed in the 90ies to help sustain the booming economy of the Clinton era, gas prices increased rapidly but were soon tamed by alternative supplies, principally LNG, which Japan had been using for years to power its manufacturing-focus boom.  By 2000, the US energy market had two large alternative and complementary supply sources for the natural gas – multiple North American fields (plus the required pipelines) and multisource LNG supplies (Middle East, Trinidad). Shale gas becomes now the third, owing to very large, economically viable fields in North America. This is what energy security and a stable and predictable market really rely on – diversified supply sources.

As many other governments do, the Romanian one decided to ignore the lessons learned from past experiences of other countries and went on to make the same mistakes, mostly from incompetence and a natural desire to avoid political heat. Lucky to have domestic reserves of natural gas, the government decided to keep a tight grip on the prices for the domestically produced gas as well as on the other aspect of the markets – regulation, control, ownership of the national gas company (Romgaz), etc. Predictably, this determined a certain level of underinvestment resulting in decreasing natural gas reserves . As the domestic production is insufficient, there is a certain dependence of a single source of gas imports, Russia, for which Romania pays a high market price. In this case, what “market” really means is the result of some form of negotiation with the Gazprom mammoth, with no realistic alternative in short and medium term. Gas storage alternatives(large empty holes in the ground where gas can be pumped in during the summer and used to smooth the supply/ demand balance during the winter) have been feasible from an economic and technical standpoint, but these initiatives have suffered enormous delays.

However, some things have changed. The privatisation of Petrom, Romania’s national integrated oil company in 2004 brought both investments and a more business-like approach. Petrom is now Romania’s premier natural gas producer having taken over Romgaz years ago. Some liberalisation of the natural gas prices is being pursued, half-heartedly and only due to the pressure of the EU. Regulation has been maintained complex, with all sorts of rules on what kind of gas (imported or local production) various domestic and industrial consumers can use and when. Such a complicated and regulated market is, as almost everywhere, the perfect recipe for inefficiency, market disturbance, fraud.  In the meantime, the blanket subsidy of low prices continues to benefit everybody, the poor as well as the wealthy and inefficient – particularly some gas-intensive industries. When the next step of liberalisation comes through, a hard political act that most politicians will try to exploit one way or another particularly in an election year, the correct economic measure (liberalise the prices and direct financial help to some categories of poor private consumers) will be swamped by a torrent of populism and incriminations. Some say that this has already started and refer to recent events, particularly a large scale prosecution of some 40+ people connected to the market (executive management and Board members of Romgaz, officials from the relevant Ministry, the owner of Romania’s largest industrial consumer of natural gas, etc.).

In a nice symmetry to the American story above, the Romanian government took a keen interest in Petrom’s plans to bypass the over-regulation of the gas market by building its own gas-fired power plant, as the electricity market is indeed liberalised. Romania’s most modern power plant, the only facility of this sort built in the country in 40 or so years, was finalised last year. However, the government decided that Petrom’s own natural gas is far too valuable to be just burned and decided that the power plant can only burn a combination of domestic and imported gas. Petrom needs to buy the imported gas (expensive) while gas from its own domestic production (cheap) will still go to the over-regulated market. This issue may not be finally settled, but it is another example of market manipulation that goes against economic efficiency.

One can only hope that years from now all this would look as childish as the American experience of 30 years ago, and Romania will have a stable, secure and  well supplied market from domestic natural gas (Romgaz, Petrom and international companies), imported (Russia and Caucaz), LNG (Qatar)and off-shore shale gas.