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Friday 5 October 2018

The finance curse: how the outsized power of the City of London makes Britain poorer

Nicholas Shaxson in The Guardian

In the 1990s, I was a correspondent for Reuters and the Financial Times in Angola, a country rich with oil and diamonds that was being torn apart by a murderous civil war. Every western visitor asked me a version of the same question: how could the citizens of a country with vast mineral wealth be so shockingly destitute?

One answer was corruption: a lobster-eating, champagne-drinking elite was getting very rich in the capital while their impoverished compatriots slaughtered each other out in the dusty provinces. Another answer was that the oil and diamond industries were financing the war. But neither of these facts told the whole story. 

There was something else going on. Around this same time, economists were beginning to put together a new theory about what was troubling countries like Angola. They called it the resource curse.

Academics had worked out that many countries with abundant natural resources seemed to suffer from slower economic growth, more corruption, more conflict, more authoritarian politics and more poverty than their peers with fewer resources. (Some mineral-rich countries, including Norway, admittedly seem to have escaped the curse.) Crucially, this poor performance wasn’t only because powerful crooks stole the money and stashed it offshore, though that was also true. The startling idea was that all this money flowing from natural resources could make their people even worse off than if the riches had never been discovered. More money can make you poorer: that is why the resource curse is also sometimes known as the Paradox of Poverty from Plenty.

Back in the 1990s, John Christensen was the official economic adviser to the British tax haven of Jersey. While I was writing about the resource curse in Angola, he was reading about it, and noticing more and more parallels with what he was seeing in Jersey. A massive financial sector on the tiny island was making a visible minority filthy rich, while many Jerseyfolk were suffering extreme hardship. But he could see an even more powerful parallel: the same thing was happening in Britain. Christensen left Jersey and helped set up the Tax Justice Network, an organisation that fights against tax havens. In 2007, he contacted me, and we began to study what we called the finance curse.

It may seem bizarre to compare wartorn Angola with contemporary Britain, but it turned out that the finance curse had more parallels with the resource curse than we had first imagined. For one thing, in both cases the dominant sector sucks the best-educated people out of other economic sectors, government, civil society and the media, and into high-salaried oil or finance jobs. “Finance literally bids rocket scientists away from the satellite industry,” in the words of a landmark academic study of how finance can damage growth. “People who might have become scientists, who in another age dreamt of curing cancer or flying people to Mars, today dream of becoming hedge-fund managers.”

In Angola, the cascading inflows of oil wealth raised the local price levels of goods and services, from housing to haircuts. This high-price environment caused another wave of destruction to local industry and agriculture, which found it ever harder to compete with imported goods. Likewise, inflows of money into the City of London (and money created in the City of London) have had a similar effect on house prices and on local price levels, making it harder for British exporters to compete with foreign competitors.

Oil booms and busts also had a disastrous effect in Angola. Cranes would festoon the Luanda skyline in good times, then would leave a residue of half-finished concrete hulks when the bust came. Massive borrowing in the good times and a buildup of debt arrears in the bad times magnified the problem. In Britain’s case, the booms and busts of finance are differently timed and mostly caused by different things. But just as with oil booms, in good times the dominant sector damages alternative economic sectors, but when the bust comes, the destroyed sectors are not easily rebuilt.

Of course, the City proudly trumpets its contribution to Britain’s economy: 360,000 banking jobs, £31bn in direct tax revenues last year and a £60bn financial services trade surplus to boot. Official data in 2017 showed that the average Londoner paid £3,070 more in tax than they received in public spending, while in the country’s poorer hinterlands, it was the other way around. In fact, if London was a nation state, explained Chris Giles in the Financial Times, it would have a budget surplus of 7% of gross domestic product, better than Norway. “London is the UK’s cash cow,” he said. “Endanger its economy and it damages UK public finances.”

To argue that the City hurts Britain’s economy might seem crazy. But research increasingly shows that all the money swirling around our oversized financial sector may actually be making us collectively poorer. As Britain’s economy has steadily become re-engineered towards serving finance, other parts of the economy have struggled to survive in its shadow, like seedlings starved of light and water under the canopy of a giant, deep-rooted and invasive tree. Generations of leaders from Margaret Thatcher to Tony Blair to Theresa May have believed that the City is the goose that lays Britain’s golden eggs, to be prioritised, pampered and protected. But the finance curse analysis shows an oversized City to be a different bird: a cuckoo in the nest, crowding out other sectors.

We all need finance. We need it to pay our bills, to help us save for retirement, to redirect our savings to businesses so they can invest, to insure us against unforeseen calamities, and also sometimes for speculators to sniff out new investment opportunities in our economy. We need finance – but this tells us nothing about how big our financial centre should be or what roles it should serve.

A growing body of economic research confirms that once a financial sector grows above an optimal size and beyond its useful roles, it begins to harm the country that hosts it. The most obvious source of damage comes in the form of financial crises – including the one we are still recovering from a decade after the fact. But the problem is in fact older, and bigger. Long ago, our oversized financial sector began turning away from supporting the creation of wealth, and towards extracting it from other parts of the economy. To achieve this, it shapes laws, rules, thinktanks and even our culture so that they support it. The outcomes include lower economic growth, steeper inequality, distorted markets, spreading crime, deeper corruption, the hollowing-out of alternative economic sectors and more.

Newly published research makes a first attempt to assess the scale of the damage to Britain. According to a new paper by Andrew Baker of the University of Sheffield, Gerald Epstein of the University of Massachusetts Amherst and Juan Montecino of Columbia University, an oversized City of London has inflicted a cumulative £4.5tn hit on the British economy from 1995-2015. That is worth around two-and-a-half years’ economic output, or £170,000 per British household. The City’s claims of jobs and tax benefits are washed away by much, much bigger harms.

‘The competitiveness agenda is an intellectual house of cards, ready to fall.’ Illustration: Katie Edwards

This estimate is the sum of two figures. First, £1.8tn in lost economic output caused by the global financial crisis since 2007 (a figure quite compatible with a range suggested by the Bank of England’s Andrew Haldane a few years ago). And second, £2.7tn in “misallocation costs” – what happens when a powerful finance sector is diverted away from useful roles (such as converting our savings into business investment) toward activities that distort the rest of the economy and siphon wealth from it. The calculation of these costs is based on established international research showing that a typical finance sector tends to reach its optimal size when credit to the private sector is equivalent to 90-100% of gross domestic product, then starts to curb growth as finance grows. Britain passed its optimal point long ago, averaging around 160% on the relevant measure of credit to GDP from 1995-2016.

This £2.7tn is added to the £1.8tn, checking carefully for overlap or double-counting, to make £4.5tn. This is a first rough approximation for how much additional GDP Britons might have enjoyed if the City had been smaller, and serving its traditional useful roles. (A third, £700bn category of “excess profits” and “excess remuneration” accruing to financial players has been excluded, to be conservative.)

But what exactly are these “misallocation costs?” There are many. For instance, you might expect the growth in our giant financial sector to provide a fountain of investment for other sectors in our economy, but the exact opposite has happened. A century or more ago, 80% of bank lending went to businesses for genuine investment. Now, less than 4% of financial institutions’ business lending goes to manufacturing – instead, financial institutions are lending mostly to each other, and into housing and commercial real estate.

Investment rates in the UK’s non-financial economy since 1997 have been the lowest in the OECD, a club that includes Mexico, Chile and Turkey. And in Britain’s supposedly “competitive” low-tax, high-finance economy, labour productivity is 20-25% lower than that of higher-tax Germany or France. Resources are being misallocated as finance has become an end in itself: unmoored, disconnected from the real economy and from the people and real businesses it ought to serve. Imagine if telephone companies suddenly became insanely profitable, and telephony grew to dwarf every other economic sector – but our phone calls were still crackly, expensive and unreliable. We would soon see that our oversized telephone sector was a burden, not a benefit to the economy, and that all those phone billionaires reflected economic sickness, not dynamism. But with everyone dazzled by our high-society, world-conquering financial centre, this glaring problem with the City seems to have been overlooked.

Half a century ago, corporations were not only supposed to make profits, but also to serve employees, communities and society. Overall taxes were high (top income tax rates were more than 90% for many years during and after the second world war) and financial flows across borders were tightly constrained, under the understanding that while trade was generally a good thing, speculative cross-border finance was dangerous. The economist John Maynard Keynes, who helped construct the global financial system known as Bretton Woods, which kept cross-border finance tightly constrained, knew this was necessary if governments were to act in their citizens’ interest. “Let goods be homespun whenever it is reasonably and conveniently possible,” he famously said. “Above all, let finance be primarily national.” The fastest economic growth in world history came in the roughly quarter of a century after the Second World War, when finance was savagely suppressed.

From the 1970s onwards, finance broke decisively free of these controls, taxes were slashed and swathes of our economies were privatised. And our businesses began to undergo a dramatic transformation: their core purposes were whittled down, through ideological shifts and changes in laws and rules, to little more than a single-minded focus on maximising the wealth of shareholders, the owners of those companies. Managers often found that the best way to maximise the owners’ wealth was not to make better widgets and sprockets or to find new cures for malaria, but to indulge in the sugar rush of financial engineering, to tease out more profits from businesses that are already doing well. Social purpose be damned. As all this happened, inequality rose, financial crises became more common and economic growth fell, as managers started focusing their attentions in all the wrong places. This was misallocation, again, but the more precise term for this transformation of business and the rise of finance is “financialisation”.

The best-known definition of the term comes from the American economist Gerald Epstein, a co-author of the new study cited above: financialisation is “the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies”. In other words, it is not just that financial institutions and credit have puffed up spectacularly in size since the 1970s, but also that more normal companies such as beermakers, media groups or online rail ticket services, are being “financialised”, to extract maximum wealth for their owners.

Take private equity firms, for instance. They typically buy up a solid company then financially engineer that company to squeeze all its different stakeholders, one by one. They run the company’s financial operations through tax havens, fleecing taxpayers. They may squeeze workers’ pay and pensions pots, or delay paying suppliers. They might buy up several companies to dominate a market niche, then milk customers for monopoly profits. They chisel the pension funds that invest alongside them, with hidden fees. And so on.

Then, armed with the juiced-up cashflows from these tactics, they borrow more against that company and pay themselves huge “special dividends” from the proceeds. If the company, newly indebted, now goes bust, the magic of “limited liability” means the private equity titans are only liable for the sliver of equity they invested in the first place – typically just 2% of the value of the company they have bought up. Private equity investors sometimes do make the companies they buy more efficient, creating wealth, but that is a minority sport compared to the financialised wealth extraction.

Or, consider the financial structure of Trainline, the online rail ticket seller. When you buy a ticket, you may pay a small booking fee, perhaps 75p. After leaving your bank account, that 75p takes an extraordinary financial journey. It starts with London-based Trainline.com Limited, then flows up to another company that owns the first, called Trainline Holdings Limited. That company is owned by another, which is owned by another and so on.

Five companies up and your brave little 75p skips off to the tax haven of Jersey, then back again to London, where it passes through five more companies, then back to Jersey, then over to Luxembourg, another tax haven. Higher up still, it passes through three or more impenetrable companies in the Cayman Islands, then joins a multitude of other rivulets and streams entering the US, where, 20 or so companies after starting, it flows to KKR, a giant US investment firm.

It flows onwards, to KKR’s shareholders, including banks, investment funds and billionaires. KKR owns or part-owns more than 180 real, solid companies including the car-sharing firm Lyft, Sonos audio systems and Trainline. But on top of those 180 real firms, KKR has at least 4,000 corporate entities, including more than 800 in the Cayman Islands, links in snaking chains of entities with peculiar names drawn from finance’s arcane lingo, like (in Trainline’s case) Trainline Junior Mezz Limited or Victoria Investments Intermediate Holdco Limited.

This is an invisible financial superstructure, siphoning wealth from Trainline’s genuinely useful and profitable services, upwards, away and offshore. None of this is remotely illegal. In our age of financialisation, this is increasingly how business is done.

In 2012, Boris Johnson, then the mayor of London, stood under an umbrella by a busy road, his blond hair whiffling in the wind. “A pound spent in Croydon is far more of value to the country from a strict utilitarian calculus than a pound spent in Strathclyde,” he gushed. “Indeed you will generate jobs and growth in Strathclyde far more effectively if you invest in Hackney or Croydon or in other parts of London.”

We are back to the idea of London as the engine of the economy. Is he right? Will pampering Croydon, London and south-east England generate wealth that can then be spread out to “Strathclyde”, Scotland and the regions? Or is London the centre of a financialising machine that sucks power and money away from the peripheries? Can an oversized City of London and the rest of Britain prosper alongside each other? Or, for the regions to prosper, must the City of London be humbled? This is perhaps the defining economic question of our times. It is a question ultimately bigger than Brexit.

The newly published research provides part of the answer; it suggests that the power of London finance is hurting Britain, to the tune of £4.5tn.
‘Private equity firms typically buy up a solid company then financially engineer that company to squeeze all its different stakeholders.’ Illustration: Katie Edwards

But let’s take a more fine-grained look. If Johnson thinks money flows from Croydon to “Strathclyde” (a Scottish administrative region, now abolished) he may wish to ponder the Strathclyde Police Training and Recruitment Centre, built by the construction firm Balfour Beatty and opened in 2002 under the now-notorious private finance initiative. Under PFI, instead of the government building and paying for projects such as schools or hospitals directly, they get private firms to borrow the money in the City to finance their construction, under a deal that the government will pay them back over, say, 25 years, with interest and extra goodies. (Cynics see PFI as an expensive way for successive governments to hide their borrowing and spending, by outsourcing it all to the private sector.)

The training centre (now called simply the Police Scotland Training Centre) sits underneath a corporate latticework nearly as complex as Trainline’s. PFI payments flow from the government to a private special purpose vehicle (SPV) called Strathclyde Limited Partnership then flow upwards from it through 10 or so companies or partnerships, to a £2bn Guernsey-based firm called International Public Partnerships Limited (INPP), then onwards via tangled shareholdings, partnerships, banking and lending arrangements, and lawyers and accountants clipping fees along the way, to other people and firms in London, South Africa, New York, Texas, Jersey, Munich, Ontario and more. The pipework is complex but the overall pattern is clear. Money flows from police budgets in Scotland, up through these financialised pipelines and into the City, posh parts of London and the south-east and offshore. Along the way, profits are being made and distributed and tax is avoided.

But there is a bigger issue than tax here. Treasury data shows that while the police training centre cost £17-18m to build, the flow of payments to the PFI consortium will add up to £112m from 2001 to 2026, well over six times as much, and vastly more than what the government would have spent if it had simply borrowed that much itself and paid Balfour Beatty directly to build it. This fits a wider pattern. The 700-odd PFI schemes in Britain had an estimated capital value of less than £59.1bn in 2017, yet taxpayers will end up paying out more than £308bn for them, well over five times that sum. PFI is a gift to the City which has resulted in, as the PFI expert Allyson Pollock acidly put it, “one hospital for the price of two”.

I have looked at several PFI corporate structures: each has a similarly convoluted financial architecture, and each involves a rain of payments from British regions (including poorer parts of London) into this central-London-focused financial nexus, overseas and offshore. And PFI is just one component of a larger picture. About £240bn, a third of the UK government’s annual budget, now goes on privately run but taxpayer-funded public services, most of it run through similarly financialised, London-focused pipelines.

On this evidence, Johnson’s picture of money flowing from Croydon to Strathclyde has it exactly back to front. These are examples of what the late geographer Doreen Massey called the “colonial relationship” between parts of London and the rest of the country. To visualise what is going on, I like to imagine old white men in top hats manipulating a Heath-Robinson-like contraption of spindly pipework perched on top of the economy, vacuuming up coins and notes and IOUs from the pockets of those underneath: the workers and users of private care homes, sexual abuse referral centres, schools, hospitals, prisons – and, of course, those of us paying mortgages on expensive homes. All are unconsciously paying tribute into this great invisible extractive machinery.

It is true, of course, that a chunk of the City’s money comes from overseas, so is not extracted from Britain. That at least must be a net benefit, surely? Not so. The core value of finance to our economy comes not from the jobs and billionaires it creates, but from the services it provides. Bringing in enormous quantities of overseas wealth doesn’t provide useful services for the British economy – but it does increase the power and wealth of the finance sector, contributing to the brain drain, the economic crises, the crashing productivity, the predatory attitudes, the misdirected lending and the subsequent inequality. Our open arms to the world’s dirty money is corrupting our politics, and it is puffing up our housing markets, penalising the young, the poor and the weak. It is all deepening the finance curse.

Finance is a great geographical sorting machine, dividing us into offshore winners and onshore losers. But it is also a sorting machine for race, gender, disability and vulnerability – taking value from those suffering reduced public services or wage cuts, and from groups made up disproportionately of women, non-white people, the elderly and the vulnerable – and delivering it to the City. It is a generational sorting machine too, as PFI, risky shadow banking profits and financialised games help the winners to jam today, with the bills sent to our kids.

This hidden tide of money flows constantly from the tired, the weak, the vulnerable huddled masses across Britain, up through these invisible filigree pipelines to a relatively small number of white European or North American men in Mayfair, Chelsea, Jersey, Geneva, the Caymans or New York. This is the finance curse in action. And it’s nice work if you can get it.

Why can’t we do something about the overwhelming power of finance? Why are the protests so muted? Why can’t we tax, regulate or police City institutions properly?

We can’t, and we don’t, not just because the City’s money talks so loudly, but also because of an ideology that has bamboozled us into thinking that we must be “competitive”. The City is going head to head with other financial centres around the world, they cry, and if we are to stay ahead in this race, we cannot hold it back with tough regulations, clod-hopping police snooping around, or “uncompetitive” tax rates. Otherwise, all that money will whoosh off to Geneva or Hong Kong. After Brexit, it will be even more urgent to stay competitive.

“We must be competitive” – it sounds great, right? Tony Blair embraced this concept, even before he slammed the Financial Services Authority in 2005, saying it was seen as “hugely inhibiting of efficient business by perfectly respectable companies that have never defrauded anyone”. David Cameron bowed down to this competitiveness agenda when he declared that “We are in a global race today... Sink or swim. Do or decline.” Theresa May reiterated the idea last month when she declared that Britain would be “unequivocally pro-business” with the lowest corporate tax rate among G20 countries.

Many people in Britain, it is true, are ambivalent about all this. They rightly fret that the City is a global money-laundering paradise, harming other nations, but (whisper it quietly) they like the hot money and oligarchs it attracts to our shores. There is a trade-off, they think, between doing the right thing and preserving our prosperity. Some do understand that if other countries follow suit with this competitiveness agenda, a race to the bottom ensues, leading to ever-lower corporate taxes, laxer financial regulation, greater secrecy, looser controls on financial crime and so on. The only answer to a race to the bottom, they gloomily conclude, is to agree some sort of multilateral armistice to get countries to co-operate and collaborate in not doing this stuff. But that is like herding squirrels on a trampoline: each country wants to out-compete the others, so there will be cheating on any deal. And it is hard to mobilise voters on this complex, distant global stuff. So, they sigh, we are stuck in this ugly race to the bottom.

But there is some tremendous good news here: these people are all flat wrong. The competitiveness agenda, driving us into this race, is intellectual nonsense resting on elementary fallacies, lazy assumptions and confusions. And this is for a few simple reasons. For one thing, economies, tax systems and cities are nothing like companies, and don’t compete like we might think. To get a taste of this, ponder the difference between a failed company, such as Carillion, and a failed state, such as Syria. Even more to the point, the finance curse shows us that if too much finance harms your economy, then pursuing more finance through the competitiveness agenda will make things worse.


In the last eight years, Britain has slashed its main corporation tax rate from 28% to 20%, cutting revenues by £16bn

Underpinning all this is the fallacy of composition, whereby the fortunes of our big businesses and big banks are conflated with the fortunes of our whole economy. Making HSBC or RBS more globally competitive, the thinking goes, will make Britain more competitive. But to the extent that their profits are extracted from other parts of the British economy, their success hurts Britain more than it helps.

To see this more clearly, consider corporate tax cuts, for instance. In the last eight years, Britain has slashed its main corporate tax rate from 28% to 20%, cutting tax revenues by more than £16bn. Theresa May now wants to go further, as a magic open-for-business elixir to address the Brexit mayhem.

What could Britain do with that £16bn? We could simultaneously run nine Oxford Universities, double the resources of Britain’s Financial Conduct Authority, treble government cybersecurity resources, and double staff numbers at HMRC, the tax authorities. Or we could send nearly half a million kids to Eton each year, if you could fit them all in. Does this trade-off somehow make Britain’s tax system, or Britain itself, more competitive? Of course not.

Corporate tax cuts are in fact just one of many varieties of goodies that we shower on the mobile financiers and multinationals. The same basic arguments hold in other areas, too. Better financial regulation brings benefits, while also scaring away the wealth-extracting predators. It is a win-win. There is no trade-off.

Words such as competitiveness and related terms (such as the even more fatuous UK Plc) are wielded to trick millions of taxpayers into thinking that it is in their own self-interest to hand over goodies – tax cuts, financial deregulation, tolerance for monopolies, turning a blind eye to crime and more – to large multinationals and financial institutions. We are permanently at a tipping point, we are told: all that investment is about to disappear down a gurgling global plughole unless we cut taxes and deregulate, NOW, I tell you.

But this is not how investment works. Big banks and financialised multinationals say they need corporate tax cuts: of course they do, just as my children say they need ice-cream. But in survey after survey, business officials say that when they are deciding where to invest, they want the rule of law, a healthy and educated workforce, good infrastructure, access to prosperous, thirsty markets, good inputs and supply chains and economic stability. All these require tax revenues. Low taxes usually come a distant fifth, sixth or seventh in their wish-lists. As the US investor Warren Buffett put it: “I have worked with investors for 60 years and I have yet to see anyone [...] shy away from a sensible investment because of the tax rate on the potential gain.”

We need investment that is embedded in the local economy, bringing jobs, skills and long-term engagement, where managers send their kids to local schools and the business supports an ecosystem of local supply chains. This is the golden stuff, and if an investment is nicely embedded, a whiff of tax won’t scare it away (even if Brexit might). Any investor who is more sensitive to tax has, almost by definition, shallower roots. So taxes will tend to discourage the flightier, more predatory, more financialised investors, who bring fewer jobs and local linkages, and higher corporate tax revenues pay for ingredients that attract investors: roads, police forces, courts, and the educated and healthy workers. To prosper, Britain should increase its effective corporate tax rates, at least for financiers and large multinationals.

Of course, you could also argue that the best way to become more competitive would be for a country to invest in and upgrade education or infrastructure, control dangerous capital flows across borders, manage the exchange rate, or carefully target industrial policies to nurture productive domestic economic ecosystems. You could insist that something called “national competitiveness” must meet the test of productivity, good jobs and a broad-based rise in living standards. There are respectable arguments along all these lines.

But these are not the visions that Blair, Cameron, May, Trump and other finance-captured leaders have been pushing. Their competitiveness agenda is about pursuing rootless global capital in a dog-eat-dog world. Give big banks and multinationals the goodies, and look the other way when they behave badly, in the craven and pathetic hope that they won’t run away.

Any country engaging in a race to the bottom on this stuff also needs to understand that the race does not stop when tax rates reach zero. There is literally no limit to the extent to which corporate players and the wealthy wish to free-ride off the taxes paid by the rest of us. Eliminate their taxes, appease them, and they will demand other subsidies, like the playground bully. Why wouldn’t they?

And yet your local car wash, your barber, or your last surviving neighbourhood fruit-and-veg merchant can’t credibly threaten to jump to Monaco if they don’t like their tax rates or fruit hygiene regulations. The agenda favours the mobile big players with handouts, leaving the domestic small fry to pay the full price of civilisation – plus a surcharge to cover the roaming members of the billionaire classes who won’t. The agenda systematically shifts wealth upwards from poor to rich, distorting our economies, reducing growth and undermining our democracies. It is always harmful.

The competitiveness agenda is a billionaire-friendly hoax. Most competent economists know this already. “If we can teach undergraduates to wince when they hear someone talk about competitiveness, we will have done our nation a great service,” the US economist Paul Krugman explained in a 1993 paper. “A government wedded to the ideology of competitiveness,” he later added, “is as unlikely to make good economic policy as a government committed to creationism is to make good science policy.”

So the competitiveness agenda is an intellectual house of cards, ready to fall. If we can topple it, we can tackle the finance curse. It is pretty straightforward, in fact. In the 1983 movie War Games, a computer geek hacks into the US Department of Defense’s supercomputer and gets dragged into a game of strategy called Global Thermonuclear War. As the game merges with reality, the machine races through thousands of scenarios before concluding: “A strange game. The only winning move is not to play.” Britain is in the same position. By joining this “competitive” global race we have not only been beggaring others – we have been beggaring ourselves, too. We can, and we must, simply step out of the race, unilaterally. That last word, unilaterally, is key. We can just stop it. This is a race for losers.

We need not bow down to the demands of monopolists, foreign oligarchs, tax-haven operators, wealth-extracting private equity moguls, too-big-to-jail banks, or PFI milkers. We can tax, regulate and police our financial sector as we ought to. Global coordination and cooperation are worth doing where possible, but we need not wait for it. And by appealing to national self-interest, we can mobilise the biggest constituency of all, and put finance back in its rightful place: serving Britain’s people, not served by them.

Thursday 4 October 2018

Will Nissan stay once Britain leaves? How one factory explains the Brexit business dilemma

David Conn in The Guardian

Earlier this year, when the British government’s assessments of the economic impact of Brexit were finally published, they revealed that the north-east of England was at risk of the deepest damage. Although the region still bears scars from the decline of heavy industry in the 1980s, today the north-east is the only part of Britain that exports more to European countries than it imports. And, amid the region’s new and rebuilt industries, such as pharmaceuticals, the most significant engine of recovery has been Nissan, the Japanese carmaker, which is housed in a giant factory complex just off the A19 at Washington, near Sunderland.

The plant was opened with great ceremony by Margaret Thatcher in 1986. Sharon Hodgson, now Labour MP for Washington and Sunderland West, which includes the plant, remembers that as a teenager, she was amazed when it was announced that Nissan would be setting up there. “Growing up in the north-east then, we had seen everything close – the mines, the shipyards, so many people put out of work. It was the cruellest, most awful time,” she said. “As a young woman, I remember the feeling of hope and optimism when Nissan came, the shock and surprise that we were actually going to get something.”

Since then, Nissan’s operation has expanded to cover a 800-acre site, running two production lines that produce 519,000 cars per year – about 55% for export to other EU countries. According to the company’s most recent annual report, for 2016-17, Nissan’s UK operation generated £6.4bn from sales, employed 7,755 people and paid these workers, mostly living in the north-east, £427m in wages. Companies supplying parts to Nissan employ a further 30,000 people across Britain.

“Nissan hasn’t been able to bring full recovery to the area; decline and deprivation are still prevalent,” said Hodgson. “But they are a massive employer, providing good jobs, including the supply chain which is so important. You have father and son working there now, a real sense of pride, and that productivity and quality is why it has been so successful.”

Yet today, there is serious concern at Nissan that Brexit threatens to damage its operation in Sunderland. The clearest explanation of how its UK business depends on EU membership was provided in February 2017 by Nissan executive Colin Lawther, appearing before parliament’s international trade committee. Lawther, a chemist by training, began his career with Nissan in 1985, as one of the key workers responsible for setting up the laboratory operation in the Sunderland plant. He went on to become Nissan Europe’s senior vice-president for manufacturing, purchasing and supply-chain management, before retiring earlier this year.

To produce as many cars as it does, Lawther explained, Nissan Sunderland needs to receive and fit 5m parts each day. Of these parts, 85% are imported, mainly from Europe. The plant holds only enough parts for half a day’s production, because it is expensive to store them, so the whole multi-billion pound operation relies on these millions of parts arriving daily with no barriers or customs delays.

Because Britain is currently part of the EU, this is a straightforward process. Each of the 28 EU member states belongs to the single market, which has been designed to facilitate trade by removing tariffs, as well as other trade and customs barriers. Rather than having 28 different industrial safety regulations, for instance, there is a single set of regulations that applies across all member states. The single market means trade between 28 different countries is free, fast and “frictionless”, just as it would be if the EU were one very large country. “Frictionless trade has enabled the growth that has seen our Sunderland plant become the biggest factory in the history of the UK car industry, exporting more than half of its production to the EU,” Nissan said, in a statement for this article.

“We build two cars every minute,” Lawther told the committee in 2017. “So you have 5m parts coming in every day, and you have half a day’s worth of stock. Any disruption to that supply chain is a complete disaster.

“We are talking about plant efficiency, downtime efficiency – to be world-class, we have to be 97% efficient. We are talking about two, three, four, six minutes a day of downtime on the production line. More than that is a disaster. If you start talking about interruption of supply of parts for hours, that is completely off the scale.”

If Britain leaves the EU without securing an agreement for continued frictionless trade – the “hard Brexit” outcome – Britain’s trading relationships would be regulated by World Trade Organisation rules, which do not allow for agreed product standards, and therefore will require customs checks at the borders with Europe. The rules also impose tariffs, including 10% on cars, 4.5% on car parts. For Nissan’s Sunderland operation, Lawther told the committee, as well as likely new delays at the borders, the impact of tariffs will add up to around £500m per year of additional costs, which would be “pretty disastrous”.

According to the government’s assessments, published in March, a “hard Brexit” would lead to a 16% economic decline in the north-east. London, by contrast, with its much more varied economy and the financial power of the City, would suffer a drop of only 3%.

The key figure in deciding the fate of Nissan’s operation in Sunderland is Carlos Ghosn, a global business executive born in Brazil to Lebanese immigrant parents, then educated in France. Ghosn, who became known as “le cost killer” after he restored the fortunes of Renault in the 1990s with his relentless efficiency drives, is not only chairman of Nissan, but also chairman of Renault and Mitsubishi, and of the Renault-Nissan-Mitsubishi Alliance that allows the three companies to work together to save costs. Renault owns 43.4% of Nissan, which in turn has bought a 15% stake in Renault, and 34% of Mitsubishi.

Since the vote to leave the EU, which was a shock to Nissan and other carmaking companies, Ghosn has consistently emphasised two main points in his occasional public statements. First, Nissan will not make further investments when they do not know what Britain’s future trading arrangements will be. Second, if leaving the EU significantly raises costs and trade barriers, Nissan will consider reducing its British operations. Sunderland is by far Nissan’s largest European plant, but the company has other factories in Europe. The current priority for the alliance, overseen by Ghosn, is a €10bn (£8.9bn) global cost-cutting programme to be implemented by 2022. It is increasingly moving towards a standard manufacturing method that can make both Renault and Nissan models. Already the Renault factories at Flins and Le Mans in France are making the Nissan Micra, in huge numbers.

Although it has invested £4bn since 1986 to make Sunderland its European base, Ghosn has said it will be reviewed if Britain becomes uncompetitive due to Brexit. “I don’t think any company can maintain its activity if it is not competitive,” Ghosn said in June. “If competitiveness is not maintained, little by little you’re going to have a decline. It may take some time, but you’re going to have a decline.”

Nissan’s Washington car plant does not look grand; it is a no-frills operation. Beyond the security gates and high railings, which are punctuated with turnstiles where the workers enter, the vast site consists of blank, imposing production sheds and basic office blocks. The main reception is a bare, functional lobby that has the feel of a 1980s school entrance. There, on a shelf, sit two Japanese Daruma dolls, which by tradition had their first eye painted – by Prince Charles and his then wife, Diana – when construction began in 1984, and the second – by Margaret Thatcher – when the plant opened on 8 September 1986.

In her landmark speech that day, Thatcher portrayed Nissan’s arrival as a British victory over the rest of Europe. “It was confirmation from Nissan,” she said, “that within the whole of Europe, the United Kingdom was the most attractive country – politically and economically – for large-scale investment.”

 
Margaret Thatcher painting the eye of the Daruma doll at the opening of the Nissan plant in 1986. Photograph: Alamy

Thatcher did not mention that Britain’s membership of the European Community (as the EU was then known) was crucial to Nissan’s decision. Yet she was fully aware of it, as were other government ministers. In a meticulously researched history of the plant’s funding via EU and UK government public money since the 1980s – adding up to almost £800m – Kevin Farnsworth of York University and his co-authors Nicki Lisa Cole and Mickey Conn (no relation) unearthed a 1980 memo to Thatcher from her industry minister, Keith Joseph. Nissan had by then decided to build a European plant in Britain, and Joseph explained:

“The deal [is] tangible evidence of the benefits to the UK of membership of the European Community; Nissan [has] chosen the United Kingdom because it [gives] them access to the whole European market. If we were outside the community, it is very unlikely that Nissan would have given the United Kingdom serious consideration as a base for this substantial investment.”

At that time, the north-east’s traditional industries were already being closed down. In 1980, British Steel shut its plant at Consett, putting 4,500 people out of work, a still powerfully remembered devastation. Shipbuilding on the river Tyne had long been declining and was parched of investment. Ashington, Easington and other communities built around coal, including Wearmouth colliery in Sunderland, were to suffer the agonising deprivations and defeat of the 1984-85 miners’ strike, which was called to fight closures. In 1992, Michael Heseltine, then president of the board of trade, would announce that 31 of the country’s remaining 50 pits would close, cutting 30,000 jobs.

When I spoke to Heseltine for this article, I asked if he conceded that his government was too brutal in these mass closures of longstanding industries. He reflected for a moment, then replied: “Probably it was too unthinking.” He said he regrets that there was no considered policy to improve these industries – through better management, company reforms and longer-term investment. “Unlike Germany, Japan, France, now China, there was never any stable industrial strategy. It was much easier to say ‘let the market rip’,” he said.

Against that landscape of collapses, Heseltine recalled the efforts to bring Nissan and other Japanese companies to Britain: “We were looking to attract anything that would help the economy. And it was a central part of the attraction to the Japanese that we were in the European Union.” The German and French governments were more protective of their own industries, Heseltine said, and the UK saw Japanese investment as an opportunity to get into the European market. Thatcher’s newly restrictive trade-union laws, which had been bitterly opposed by unions, were also part of her government’s pitch: that workers would be less able to strike and easier to lay off than in other European countries. The Washington plant has, however, always been strongly unionised.

For the Japanese companies, Heseltine said, the UK was the “soft underbelly” of Europe, a way in. Shinichi Iida, minister for public diplomacy and media at the Japanese embassy in London, confirmed that Japanese companies were courted by Thatcher’s government, telling me that many Japanese companies “have a strong sense that they came here at the invitation of the UK at that time”. In 1989, two other major Japanese car manufacturers followed Nissan’s lead: Honda, which now makes models of the Civic for export, about a third to the EU, from its factory in Swindon, and Toyota, which describes its car plant at Burnaston, near Derby, and its engine factory in Deeside, north Wales, as “European production centres”.

The English language was a big draw to the UK for Japanese manufacturing companies, as was its tradition of research and development, and “the very strict and open legal system”, Iida said – but it was “quite essential” that the UK was “a gateway to Europe”. Sir Ian Gibson, who was recruited by Nissan from Ford in 1984 to establish and run the Washington plant, confirms that: “The whole premise of the investment was that it was a European base; there would be free access to the European market.”

Ged Parker, who was on the negotiating team for the local regeneration authority, recalled their pitch to Nissan. They had a huge site available on an old airfield, the former RAF Usworth; they had the north-east’s industrial tradition and experienced workforce; there was proximity to the A19, the A1, Newcastle airport and – most crucially – the ports on the Tyne, Tees and Wear for shipping parts and finished cars to and from Europe.

The north of England development council had hired a representative in Japan, Ken Oshima, to drum up business, and Parker remembers the enthusiasm of the visiting Nissan executives. “The delegation were engineers – they were technical people and they had a reverence for British industry.” They could also see that the area was able to complete major construction projects; Washington new town had just been built, a planned layout of new housing, industrial estates and shops, near historic Washington village, where the first US president George Washington had his family roots.

The team deployed an array of winning tactics to impress Nissan. “The proposal document was the first we ever did on a word processor,” Parker said. The authority had bought two computers just a few weeks before Nissan’s visit. “It was leading-edge technology then.”

Crucial, though, were huge grants of public money, provided by the UK because the north-east was classified as a special development area, in need of investment. According to Farnsworth, by 1984 the government had pledged £112m from the regional development and selective financial assistance schemes, to secure and prepare the site for Nissan’s investment. The airfield was classed as agricultural land, and sold at a heavy discount.

On 30 March 1984, Nissan finally signed the agreement to invest in Washington. “It was an unbelievable feeling,” said Parker. “It was a career high for me. The north-east has always felt hard done by, and it almost changed morale overnight. What Nissan has done since, expanded so much, particularly in recent years, dragged more industry up here, spread good practice, has been huge for the region.”

The first model made at the plant in 1986, when it employed 430 people, was the Nissan Bluebird. Gibson said they began with a target of 24,000 cars a year. The Primera model replaced the Bluebird in 1990, and two years later, the plant began to make a second model as well, the Micra. By 2000, the plant was producing three models – and a total of 300,000 cars each year.

Although the financial crisis hurt Nissan and 1,200 jobs were axed in January 2009, the British plant’s fortunes recovered more quickly than others. The Juke, Leaf, Infiniti and Qashqai models were all commissioned at Washington from 2010 onwards, attracting more multi-million pound investment in plant and machinery by Nissan, and a new round of expansion.

 
Nissan workers prepare doors for the Qashqai car in Sunderland. Photograph: Reuters

When Nissan needs to decide on new investments, such as where new models are to be built, individual plants mount competing internal bids to the main board. “The plants with the best claim get the investment,” Gibson explained. “And the ones with the best claim have the least friction and risk. Sunderland, for a long time, was the best claim.”

Inside the basic, shed-like structure that houses the production lines is dizzyingly intricate, hugely expensive technology geared towards the “just in time” assembly of a car, mostly Qashqais, every minute. One of the Unite officials described the job on the line as “very hard, physically demanding”, and it looks it. The workers, mostly men, are on their feet throughout an eight-hour shift, tightly focused on machine-fitting engines, doors, dashboards and windscreens to the car bodies that come along the line each minute. Overhead, another line is sending down finished wheels, to be attached at the end of the process. Another team carries out rapid tests on the cars, then transporters take them out and to the port.

The Sunderland factory does not go in much for the modern trend of decorating the workers’ areas with ambient colours or motivational slogans, but there is one small sign next to the production lines. It says: “Nissan Sunderland Plant: SECOND TO NONE.”

In the months before the EU referendum, the Labour party’s official remain campaign, led by the former home secretary Alan Johnson, approached Nissan to ask if it could stage its north-east launch event at the Washington plant. The politicians wanted to showcase an economic, industrial and employment success that had clearly been built on EU membership.

Nissan declined. Despite the impact Brexit was likely to have on their businesses, senior executives at most major companies took the view that it was unlikely voters would decide to leave, and there was little to be gained by being too forthright on a political issue. When Nissan finally did make a statement, it was an exercise in restraint. “Our preference,” it said, “is, of course, that the UK stays within Europe – it makes the most sense for jobs, trade and costs. For us a position of stability is more positive than a collection of unknowns. While we remain committed to our existing investment decisions, we will not speculate on the outcome nor what would happen in either scenario.”

 
Nissan Qashqais and Leafs being inspected at the port of Tyne before export. Photograph: Bloomberg via Getty

Unite also told its members that the union favoured remaining in the EU. “The damage Brexit can do is a massive concern, and we did campaign to remain,” says Tony Burke, Unite’s assistant general secretary with responsibility for manufacturing. One Unite official at the plant, who did not want to be named due to the sensitivity, still, of talking about Brexit, said he felt Nissan’s statement was “very neutral” and did not communicate to the workers how much was at stake. He said they did their best with Unite’s message, but it was “just one voice, one hit, in months of hysteria ramped up by the media, particularly about hostility to immigrants. That’s what people were listening to.”

Politically, Sunderland is overwhelmingly Labour: its three constituency MPs all represent the party, and in 2016, Labour won 67 of the 75 seats on Sunderland city council. The MPs and council campaigned for Britain to remain in the EU, but on the doorsteps, they found that people were planning to vote leave in large numbers.

In the referendum, 61% of Sunderland’s voters chose leave. When I visited the plant recently, I talked to several workers as they came off a shift. Most had voted leave. One young man, 24, who, like the others I spoke to, did not want to be named, said he had voted remain because he preferred stability and he “thought we’re fine as we are”, but that older workers around him had voted leave. “They said that they didn’t see a change from before and after we joined the EU, and some said they didn’t like the EU making rules for us.”

An older man, 55, pointed to one of the huge sheds behind us and said, like others, that Nissan’s multi-million pound investment in it shows the Sunderland plant is secure. He said he had voted leave to stop immigration, “EU interference”, and because the north-east gets “bugger all money” from the EU.

In fact, after Cornwall, the north-east receives England’s second-highest amount of EU structural funding proportionate to its population, according to a report compiled before the referendum for Sunderland’s public and private sector partnership, the Economic Leadership Board. The current round of EU funding, being managed by the region’s local enterprise partnership, is £437m between 2014 and 2020. Nissan itself, according to Farnsworth’s research, has received £450m in loans from the European Investment Bank, and £347m in grants and other public funding, from the UK and EU.

Another Nissan worker, 63, sitting on a barrier waiting for his lift home, said he had voted leave, like many of his colleagues, because he was “sick of the EU deciding our laws”. I asked him if he accepted that leaving was damaging to the car industry, and to Nissan. He did, he replied, then smiled, and said that would still not prompt him to change his mind.

Since the referendum, Nissan’s chairman, Ghosn, has regularly made public warnings that the operations in Sunderland will be reduced over the long term if Brexit makes the UK uncompetitive. Gibson says Britain’s lack of preparation and chaotic political process is creating “a terrible impression” with the Japanese.

Gibson knows the company intimately. After helping to establish the Sunderland plant, he went on to become president of Nissan Europe, and the first European to join the main Nissan board in Japan. “Of course, it is realistic that Nissan could stop investing in the plant; it’s the most likely outcome,” he said. “Now it is a three-company alliance; there are lots of Renault plants screaming out for future models, and Nissan plants in Spain. Why go to Sunderland, which will have more frictions and risk, and be isolated?”

During his time at Nissan – he left in 2001, after 17 years – Gibson was struck by the way Japanese business culture focused single-mindedly on careful scrutiny of the data. “They have a very rational decision-making culture,” he said. “They examine the evidence, and have a very tough debate to reach a rational conclusion.” Iida, the Japanese embassy minister, agreed with Gibson’s assessment: “It takes time for them to take a decision, but once they do, they simply don’t waver it so easily.”

Within the car industry there is exasperation, and even disdain, for the pro-Brexit argument that British-based companies will be freed from ties with the EU to “go global”. Nissan and the other major manufacturers, including suppliers, are already global; they have huge plants in the US, China, Japan, Mexico, Brazil, Argentina, India and Russia. The Sunderland plant was allocated one model, the Infiniti, for export to the US, and sells some other cars around the world, but as Ghosn has emphasised, the plant is there principally to serve Europe, not to ship expensively to other continents where Nissan already has plants. Car manufacturers locate a factory in one country to serve that geographical region; Ghosn has consistently referred to Nissan’s Sunderland plant as “a European investment based in the UK”.

In September 2016, Ghosn suggested that the company’s plan to select Sunderland as the European plant to assemble its new Qashqai and X-Trail models was at risk following the referendum, and stated that the government needed to provide “commitments for compensation” if Brexit increased costs. In response, the government scurried to reassure Nissan. May met Ghosn personally, and the business secretary, Greg Clark, flew to Japan to meet senior executives. There then followed a period of correspondence that has still not been made public.

Following this government effort, on 27 October Nissan’s global headquarters in Yokohama announced that it would indeed build its new Qashqai and X-Trail models in England, “securing and sustaining the jobs of more than 7,000 workers at the [Sunderland] plant”.

Nissan has since insisted that Ghosn’s call for “compensation” was misunderstood, and was never a request for direct subsidy. However, the government has allocated considerable further UK and EU funding that has had the effect of helping Nissan. One of Nissan’s priorities, emphasised by Colin Lawther in his evidence in parliament, has been to bring more suppliers to the north-east, saving the company costs of importing and transport. In January 2017, only a few months after its intense period of correspondence with Nissan, £41m of EU funding was allocated by the north-east local enterprise partnership towards the construction of a new international advanced manufacturing park (IAMP), across the road from the Washington plant. Nissan suppliers are planned to locate on the site, where initial construction began in August.

That grant accounted for more than 80% of the £50m EU funding the local enterprise partnership had to spend in that round, so other regional infrastructure projects lost out. The chair, Andrew Hodgson, said he has never asked to see the exchange of letters between Nissan and the government, but that: “It was very clear, from a north-east perspective, we needed to invest in the IAMP.”

In March 2017, the BBC managed to uncover a small part of the correspondence between Nissan and the government. Paul Willcox, then chair of Nissan Europe, had proposed the need for more investment in electric vehicles, of which Nissan’s Leaf model is a market leader. Soon after the exchange of letters, the government announced that it would be making a multi-million pound investment in more charging points and other incentives to develop electric cars. Clark’s department for business, energy and industrial strategy has said that commitment followed general policy and was not specific to helping Nissan.

Farnsworth, the York University academic who has researched the public funding for Nissan in the UK, suggests that Brexit is already leading the British government to be defensive, desperate to keep the investment the country already has. Brexit, his report says, “gives Nissan nearly unprecedented bargaining power with the UK government. These circumstances put the government in the position of having to give Nissan exactly what it wants in order for the company to remain in the UK.”

Despite the government’s efforts to reassure Nissan, Ghosn has repeated warnings that further investment decisions are on hold. It was in June, speaking to the BBC, that he warned of gradual decline if competitiveness is damaged. “So far we have absolutely no clue how this is going to end up,” he also said. “We don’t want to take any decisions in the dark. We don’t want to take any decisions we might regret in future”.

In their statement for this article, Nissan, still quite restrained, nevertheless echoed Ghosn’s warning. “Today we are among those companies with major investments in the UK who are still waiting for clarity on what the future trading relationship between the UK and the EU will look like,” it said. “As a sudden change from those rules to the rules of the WTO will have serious implications for British industry, we urge UK and EU negotiators to work collaboratively towards an orderly, balanced Brexit that will continue to encourage mutually beneficial trade.”

Iida, at the Japanese embassy, said the priority is to avoid a hard Brexit: “Japanese companies have been seriously taking risk-hedge measures,” he said. “For example, Japanese financial institutions have already submitted business applications to cities such as Frankfurt and Amsterdam, and Japanese manufacturing companies are very quietly holding off their future investment plans.”

Since the referendum, and particularly since the publication of the government’s impact assessments earlier this year, James Ramsbotham, chief executive of the north-east chamber of commerce since 2006, has been voicing increasingly urgent warnings about the threat to the region’s economy. None of the government’s responses, or its conduct of the negotiations since, he says, have reassured him.

When I told him that Michael Heseltine had reflected on the 1980s closures of the north-east’s coal mines and heavy industry as “too unthinking”, Ramsbotham instinctively drew a parallel with Brexit: “Aren’t we in danger of doing the same unthinking thing now?” he responded. “Delivering another potentially catastrophic shock to the economy, without sufficient thinking, planning or foresight?”

Finance, the media and a catastrophic breakdown in trust

John Authers in The Financial Times


Finance is all about trust. JP Morgan, patriarch of the banking dynasty, told Congress in the 1912 hearings that led to the foundation of the US Federal Reserve, that the first thing in credit was “character, before money or anything else. Money cannot buy it. 

“A man I do not trust could not get money from me on all the bonds in Christendom,” he added. “I think that is the fundamental basis of business.” He was right. More than a century later, it is ever clearer that, without trust, finance collapses. That is no less true now, when quadrillions change hands in electronic transactions across the globe, than it was when men such as Morgan dominated markets trading face to face. 

And that is a problem. Trust has broken down throughout society. From angry lynch mobs on social media to the fracturing of the western world’s political establishment, this is an accepted fact of life, and it is not merely true of politics. Over the past three decades, trust in markets has evaporated. 

In 1990, when I started at the Financial Times, trust in financiers and the media who covered them was, if anything, excessive. Readers were deferential towards the FT and, particularly, the stone-tablet certainties of the Lex column, which since the 1930s has dispensed magisterial and anonymous investment advice in finely chiselled 300-word notes. 

Trainee bankers in the City of London were required to read Lex before arriving at the office. If we said it, it must be true. Audience engagement came in handwritten letters, often in green ink. Once, a reader pointed out a minor error and ended: “The FT cannot be wrong, can it?” I phoned him and discovered this was not sarcasm. The FT was and is exclusively produced by human beings, but it had not occurred to him that we were capable of making a mistake. 

Back then, we made easy profits publishing page after page of almost illegible share price tables. One colleague had started in the 1960s as “Our Actuary” — his job was to calculate, using a slide rule, the value of the FTSE index after the market closed. 

Then came democratisation. As the 1990s progressed, the internet gave data away for free. Anyone with money could participate in the financial world without relying on the old intermediaries. If Americans wanted to shift between funds or countries, new online “ fund supermarkets” sprung up to let them move their pension fund money as much as they liked. 

Technology also broke the hold of bankers over finance, replacing it with the invisible hand of capital markets. No longer did banks’ lending officers decide on loans for businesses or mortgages; those decisions instead rested in the markets for mortgage-backed securities, corporate paper and junk bonds. Meanwhile, banks were merged, deregulated and freed to re-form themselves. 

But the sense of democratisation did not last. The crises that rent the financial world in twain, from the dotcom bubble in 2000 through to the 2008 Lehman debacle and this decade’s eurozone sovereign debt crisis, ensured instead that trust broke down. That collapse appears to me to be total: in financial institutions, in the markets and, most painfully for me, in the financial media. Once our word was accepted unquestioningly (which was unhealthy); now, information is suspect just because it comes from us, which is possibly even more unhealthy. 

To explain this, let me tell the story of the most contentious trip to the bank I have ever made. 

Two days after Lehman Brothers declared bankruptcy, in September 2008, I went on an anxious walk to my local bank branch. Working in New York, I had recently sold my flat in London and a large sum had just landed in my account at Citibank — far more than the insured limit, which at that point was $100,000. 

It did not seem very safe there. Overnight, the Federal Reserve had spent $85bn to bail out the huge insurance company AIG, which had unwisely guaranteed much credit now sitting on banks’ books. Were AIG to go south, taking its guarantees with it, many banks would suddenly find themselves with worthless assets and become insolvent. 

Meanwhile, a money market fund had “broken the buck”. Money market funds were treated like bank accounts by their clients. They switch money between very safe short-term bonds, trying to find higher rates than a deposit account can offer. Each share in the fund is worth $1, interest is distributed and the price cannot dip below $1. As the funds did not pay premiums for deposit insurance, they could pay higher interest rates for no perceived extra risk. 

Thus there was outright panic when a large money market fund admitted that it held Lehman Brothers bonds, that its price must drop to 97 cents and that it was freezing access to the fund. Across the US, investors rushed to pull their money out of almost anything with any risk attached to it, and poured it into the safest investments they could find — gold and very short-term US government debt (Treasury bills, or T-bills). This was an old-fashioned bank run, but happening where the general public could not see it. Panic was only visible to those who understood the arcana of T-bill yields.

Our headline that day read “Panic grips credit markets” under a banner about the “banking crisis” in red letters. 

There was no time to do anything complicated with my own money. Once I reached my lunch hour, I went to our local Citi branch, with a plan to take out half my money and put it into rival bank Chase, whose branch was next door. This would double the amount of money that was insured. 

This is how I recounted what happened next, in a column for the FT last month: 

“We were in Midtown Manhattan, surrounded by investment banking offices. At Citi, I found a long queue, all well-dressed Wall Streeters. They were doing the same as me. Next door, Chase was also full of anxious-looking bankers. Once I reached the relationship officer, who was great, she told me that she and her opposite number at Chase had agreed a plan of action. I need not open an account at another bank. Using bullet points, she asked if I was married and had children. Then she opened accounts for each of my children in trust and a joint account with my wife. In just a few minutes I had quadrupled my deposit insurance coverage. I was now exposed to Uncle Sam, not Citi. With a smile, she told me she had been doing this all morning. Neither she nor her friend at Chase had ever had requests to do this until that week.” 

Ten years on, this is my most vivid memory of the crisis. The implications were clear: Wall Streeters, who understood what was going on, felt they had to shore up their money in insured deposits. The bank run in the trading rooms was becoming visible in the bank branches down below. 

In normal circumstances, the tale of the bank branch would have made an ideal anecdote with which to lead our coverage, perhaps with a photo of the queue of anxious bankers. Low T-bill yields sound dry and lack visual appeal; what I had just seen looked like a bank run. (Although technically it was not — nobody I saw was taking out money.) 

But these were not normal circumstances, and I never seriously considered writing about it. Banks are fragile constructs. By design, they have more money lent out than they keep to cover deposits. A self-fulfilling loss of confidence can force a bank out of business, even if it is perfectly well run. In a febrile environment, I thought an image of a Manhattan bank run would be alarmist. I wrote a piece invoking a breakdown in trust between banks and described the atmosphere as “panic”, but did not mention the bank branch. Ten years later, with the anniversary upon us, I thought it would be an interesting anecdote to dramatise the crisis. 

In the distrustful and embittered world of 2018, the column about what I saw and why I chose not to write about it provoked a backlash that amazed me. Hundreds of responses poured in. Opinion was overwhelmingly against me. 

One email told me: “Your decision to save yourself while neglecting your readership is unforgivable and in the very nature of the elitist Cal Hockley of the Titanic scrambling for a lifeboat at the expense of others in need.” One commenter on FT.com wrote: “This reads like Ford trying to explain why pardoning Nixon was the right thing to do.” 

“I have re-read the article, and the comments, a couple of times,” wrote another. “And I realised that it actually makes me want to vomit, as I realise what a divide there is between you and I, between the people of the establishment like yourself, and the ordinary schmucks like myself. The current system is literally sickening and was saved for those who have something to protect, at the expense of those who they are exploiting.” 

Feedback carried on and on in this vein. How could we in the media ever be trusted if we did not tell the whole truth? Who were we to edit the facts and the truth that were presented? Why were we covering up for our friends in the banks? Newspaper columns attacking me for my hypocrisy popped up across the world, from France to Singapore. 

I found the feedback astonishing and wrong-headed. But I am now beginning to grasp the threads of the problem. Most important is the death of belief in the media as an institution that edits and clarifies or chooses priorities. Newspapers had to do this. There was only so much space in the paper each day. Editing was their greatest service to society. 

Much the same was true of nightly half-hour news broadcasts in pre-cable television. But now, the notion of self-censorship is alien and suspect. People expect “the whole truth”. The idea of news organisations with long-standing cultures and staffed by trained professionals deciding what is best to publish appears bankrupt. We are not trusted to do this, and not just because of politicians crying “fake news”. 

Rather, the rise of social media has redefined all other media. If the incident in the Citi branch were to happen today, someone would put a photo of it on Facebook and Twitter. It might or might not go viral. But it would be out there, without context or explanation. The journalistic duty I felt to be responsible and not foment panic is now at an end. This is dangerous. 

Another issue is distrust of bankers. Nobody ever much liked “fat cats”, but this pickled into hatred as bankers avoided personal criminal punishment for their roles in the crisis. Bank bailouts were, I still think, necessary to protect depositors. But they are now largely perceived merely as protecting bankers. My self-censorship seemed to be an effort to help my friends the bankers, not to shield depositors from a panic. 

Then there is inequality. In my column, I said that I “happened to have a lot of money in my account” but made no mention of selling my London flat. People assumed that if I had several hundred thousand dollars sitting in a bank account, I must be very rich. That, in many eyes, made my actions immoral. Once I entered the FT website comments thread to explain where the money had come from, some thought this changed everything. It was “important information”. “In the article where moral questions [were] raised, the nature of the capital should have been explained better,” one commenter said. 

The hidden premise was that if I were rich, I would not have been morally entitled to protect my money ahead of others lacking the information I was privy to. Bear in mind that to read this piece, it was necessary to subscribe to the FT. 

Put these factors together, and you have a catastrophic breakdown in trust. How did we get here? 

The democratisation of finance in the 1990s was healthy. Transparency revealed excessive fees that slowly began to fall. For us at the FT, in many ways an entrenched monopoly, this meant lost advertising and new competition from cable TV, data providers and an array of online services. 

But that democratisation was tragically mishandled and regulators let go of the reins far too easily. In 1999, as the Nasdaq index shot to the sky, the share prices of new online financial media groups such as thestreet.com shot up with them. On US television, ads for online brokers showed fictional truck drivers apparently buying their own island with the proceeds of their earnings from trading on the internet. By 2000, when I spent time at business school, MBA students day-traded on their laptops in class, oblivious to what their professors were saying. 

Once that bubble burst, the pitfalls of rushed democratisation were painfully revealed. Small savers had been sucked into the bubble at the top, and sustained bad losses. 

Trust then died with the credit crisis of 2008 and its aftermath. The sheer injustice of the ensuing government cuts and mass layoffs, which deepened inequality and left many behind while leaving perpetrators unpunished, ensured this. 

The public also lost their trust in journalists as their guides in dealing with this. We were held to have failed to warn the public of the impending crisis in 2008. I think this is unfair; the FT and many other outlets were loudly sceptical and had been giving the problems of US subprime lenders blanket coverage for two years before Lehman Brothers went down. In the earlier dotcom bubble, however, I think the media has more of a case to answer — that boom was lucrative for us and many were too credulous, helping the bubble to inflate. 

Further, new media robbed journalists of our mystique. In 1990, readers had no idea what we looked like. Much of the FT, including all its stock market coverage, was written anonymously. The only venue for our work was on paper and the only way to respond (apart from the very motivated, who used the telephone) was also on paper. The rule of thumb was that for every letter we received, at least another hundred readers felt the same way. 

Now, almost everything in the paper that expresses an opinion carries a photo. Once my photo appeared above my name on the old Short View column, my feedback multiplied maybe fivefold. The buzzword was to be “multimodal”, regaling readers with the same ideas in multiple formats. In 2007 we started producing video. 

My readers became my viewers, watching me speak to them on screen every day, and my feedback jumped again. Answering emails from readers took over my mornings. Often these would start “Dear John”, or even just “John”, as though from people who knew me. So much for our old mystique. 

By 2010, social media was a fact of life. Writing on Twitter, journalists’ social network of choice, became part of the job. People expected us to interact with them. This sounds good. We were transparent and interactive in a way we had not been before. But it became part of my job to get into arguments with strangers, who stayed anonymous, in a 140-character medium that made the expression of any nuance impossible. 

Meanwhile, the FT hosted social media of its own. Audience engagement became a buzzword. If readers commented, we talked back. Starting in 2012, I started debating with readers and I learnt a lot. FT readers are often specialists, and they helped me understand some arcane subject matter. Once, an intense discussion with well over a hundred entries on the subject of cyclically adjusted price/earnings multiples (don’t ask) yielded all the research I needed to write a long feature. 

Now, following Twitter, comments below the line are degenerating into a cesspit of anger and disinformation. Where once I debated with specialists, now I referee nasty political arguments or take the abuse myself. The status of the FT and its competitors in the financial media as institutions entrusted with the task of giving people a sound version of the truth now appears, to many, to be totally out of date. 

Even more dangerously for the future, the markets and their implicit judgments have been brought into the realm of politics (and not just by President Trump). This was not true even 20 years ago; when Al Gore faced off against George W Bush in 2000, only months after the dotcom bubble burst, neither candidate made much of an issue of it. 

But now, following Lehman, people understand that decisions made in capital markets matter. That makes markets part of the political battlefield; not just how to interpret them, but even the actual market numbers are now open to question. 

Brexit rammed this home to me. During the 2016 referendum campaign, Remainers argued that voting to leave would mean a disastrous hit for sterling. This was not exactly Project Fear; whether or not you thought Brexit was a good idea, it was obvious that it would initially weaken the pound. A weaker currency can be good news — the pound’s humiliating exit from the EU’s exchange rate mechanism in 1992, for example, set the scene for an economic boom throughout the late 1990s. 

But reporting on the pound on the night of the referendum was a new and different experience. Sitting in New York as the results came in through the British night, I had to write comments and make videos, while trying to master my emotions about the huge decision that my home country had just taken. Sterling fell more than 10 per cent against the dollar in a matter of minutes — more than double its previous greatest fall in the many decades that it had been allowed to float, bringing it to its lowest level in more than three decades. Remarkably, that reaction by foreign exchange traders has stood up; after two more years of political drama, the pound has wavered but more than two years later remains slightly below the level at which it settled on referendum night. 

As I left, at 1am in New York, with London waking up for the new day, I tweeted a chart of daily moves in sterling since 1970, showing that the night’s fall dwarfed anything previously seen. It went viral, which was not surprising. But the nature of the response was amazing. It was a factual chart with a neutral accompanying message. It was treated as a dubious claim. 

“LOL got that wrong didn’t you . . . oops!” (There was nothing wrong with it.) “Pretty sure it was like that last month. Scaremongering again.” (No, it was a statement of fact and nothing like this had happened ever, let alone the previous month.) 

“Scaremongering. Project Fear talking us down. This is nothing to do with Brexit, it’s to do with the PM cowardice resignation.” (I had made the tweet a matter of hours before David Cameron resigned.) 

The reaction showed a willingness to doubt empirical facts. Many also felt that the markets themselves were being political and not just trying to put money where it would make the greatest return. “Bankers punish Britons for their audacity in believing they should have political control of their own country.” (Forex traders in the US and Asia were probably not thinking about this.) 

“It will recover, this is what uncertainty does. Also the rich bitter people upset about Brexit.” (Rich and bitter people were unlikely to make trades that they thought would make them poorer, and most of that night’s trading was by foreigners more dispassionate than Britons could be at that point.) 

So it continued for days. Thanks to the sell-off in sterling, the UK stock market did not perform that badly (unless you compared it with others, which showed that its performance was lousy). Whether the market really disliked the Brexit vote became a topic of hot debate, which it has remained — even as the market verdict, that Brexit is very bad news if not a disaster, becomes ever clearer. 

After Brexit, of course, came Trump. The US president takes the stock market as a gauge of his performance, and any upward move as a political endorsement — while his followers treat any fall, or any prediction of a fall by pundits such as me, as a political attack. The decade in which central banks have bought assets in an open attempt to move markets plays into the narrative that markets are political creations. 

This is the toxic loss of trust that now vitiates finance. Once lost, trust is very hard to retrieve, which is alarming. It is also not clear what the financial media can do about it, beyond redoubling our efforts to do a good job. 

All the most obvious policy responses come with dangers. Regulating social media from its current sick and ugly state would have advantages but would also be the thin end of a very long wedge. Greater transparency and political oversight for central banks might rebuild confidence but at the risk of politicising institutions we desperately need to maintain independence from politicians. And an overhaul of the prosecutorial system for white-collar crime, to avert the scandalous way so many miscreants escaped a reckoning a decade ago, might work wonders for bolstering public trust — but not if it led to scapegoating or show trials. 

On one thing, I remain gloomily clear. Without trust in financial institutions themselves, or those who work in them, or the media who cover them, the next crisis could be far more deadly than the last. Just ask JP Morgan.

Do not blame accounting rules for the financial crisis

Hans Hoogervorst in The Financial Times

Ten years after the outbreak of the financial crisis, there are still persistent arguments about the role that accounting standards may have played in its genesis.

Some critics of International Financial Reporting Standards argue that they gave an overly rosy picture of banks’ balance sheets before the crisis and are still not prudent enough despite improvements since then. These same critics also argue that excessive reliance on fair value accounting, which reflects an asset’s current market value, has encouraged untimely recognition of unrealised profits.

They want to require banks to make upfront provisions for all expected lifetime losses on loans and, presumably, a return to good old historical cost accounting, which values assets at the price they were initially purchased.

Though superficially appealing, these changes would weaken prudent accounting, rather than strengthen it.

The British bank HBOS, which collapsed and was taken over by Lloyds Banking Group during the crisis, has been presented as an example of failing pre-crisis accounting standards. The truth is that HBOS met bank regulators’ capital requirements, and its financial statements clearly showed that its balance sheet was supported by no more than 3.3 per cent of equity. For investors who cared to look, the IFRS standards did a quite decent job of making crystal clear that many banks had wafer-thin capital levels and were accidents waiting to happen.
However, the crisis did reveal that the existing standards gave banks too much leeway to delay recognition of inevitable loan losses. In response, the International Accounting Standards Board developed an “expected loss model” that significantly lowered the thresholds for recognising loan losses. The new standard, IFRS 9, requires banks to initially set aside a moderate provision for loan losses on all loans. This prevents them from recognising too much profit up front. Then if a loan experiences a significant increase in credit risk, all the losses that can be expected over the lifetime of the loan must be recognised immediately. Normally, that will happen long before actual default.

In developing this standard, the IASB did consider whether to require banks to recognise full lifetime losses from day one. We rejected this approach for several reasons.

First, accounting standards are designed to reflect economic reality as closely as possible. Banks do not suffer losses on the very first day a loan has been made, so recording a full lifetime loss immediately is counter-intuitive. Moreover, in bad economic times, when earnings are already depressed, banks would have an incentive to cut back on new lending in order to avoid having to recognise large day one losses. Just when you need it most, the economy would probably be starved of credit.

Second, future losses are notoriously difficult to predict, so any model based on expected losses many years later would be subjective. Before the crisis, Spanish regulators required their banks to provision for bad times on the basis of lifetime expected losses. But their lenders underestimated and were still overwhelmed by the tide of bad loans. This kind of accounting also tempts banks to overstate losses in good times, creating reserves that could be released in bad times. That may seem prudent at first but could mask deteriorating performance in a later period, when investors are most in need of reliable information.

Critics also allege that IFRS has been too enamoured of fair value accounting. In fact, banks value almost all of their loan portfolios at cost, so the historical cost method remains much more pervasive.

Fears that fair value accounting lead to improper early profit recognition are also overblown. IFRS 9 prohibits companies from doing that when quoted prices in active markets are not available and the quality of earnings is highly uncertain. Moreover, fair value accounting is often quicker at identifying losses than cost accounting. That is why banks lobbied so actively against it during the crisis.

This does not mean that the accounting standards are infallible. Accounting is highly dependent on the exercise of judgement and is therefore more an art than a science. Good standards limit the room for mistakes or abuse, but can never entirely eliminate them. The capital markets are full of risks that accounting cannot possibly predict. This is certainly the case now, with markets swimming in debt and overpriced assets. For accounting standards to do their job properly, we need management to own up to the facts — and auditors, regulators and investors to be vigilant.

Wednesday 3 October 2018

Our cult of personality is leaving real life in the shade

George Monbiot in The Guardian

By reducing politics to a celebrity obsession – from Johnson to Trump to Corbyn – the media misdirects and confuses us 

Illustration: Ben Jennings


What kind of people would you expect the newspapers to interview most? Those with the most to say, perhaps, or maybe those with the richest and weirdest experiences. Might it be philosophers, or detectives, or doctors working in war zones, refugees, polar scientists, street children, firefighters, base jumpers, activists, writers or free divers? No. It’s actors. I haven’t conducted an empirical study, but I would guess that between a third and a half of the major interviews in the newspapers feature people who make their living by adopting someone else’s persona and speaking someone else’s words.

This is such a bizarre phenomenon that, if it hadn’t crept up on us slowly, we would surely find it astounding. But it seems to me symbolic of the way the media works. Its problem runs deeper than fake news. What it offers is news about a fake world.

I am not proposing that the papers should never interview actors, or that they have no wisdom of their own to impart. But the remarkable obsession with this trade blots out other voices. One result is that an issue is not an issue until it has been voiced by an actor. Climate breakdown, refugees, human rights, sexual assault: none of these issues, it seems, can surface until they go Hollywood.

This is not to disparage the actors who have helped bring them to mainstream attention, least of all the brave and brilliant women who exposed Harvey Weinstein and popularised the #MeToo movement. But many other brave and brilliant women stood up to say the same thing – and, because they were not actors, remained unheard. The #MeToo movement is widely assumed to have begun a year ago, with Weinstein’s accusers. But it actually started in 2006, when the motto was coined by the activist Tarana Burke. She and the millions of others who tried to speak out were, neither literally nor metaphorically, in the spotlight.

At least actors serve everyone. But the next most-interviewed category, according to my unscientific survey, could be filed as “those who serve the wealthy”: restaurateurs, haute couturists, interior designers and the like, lionised and thrust into our faces as if we were their prospective clients. This is a world of make-believe, in which we are induced to imagine we are participants rather than mere gawpers.

The spotlight effect is bad enough on the culture pages. It’s worse when the same framing is applied to politics. Particularly during party conference season, but at other times of the year as well, public issues are cast as private dramas. Brexit, which is likely to alter the lives of everyone in Britain, is reduced to a story about whether or not Theresa May will keep her job. Who cares? Perhaps, by now, not even Theresa May.

Neither May nor Jeremy Corbyn can carry the weight of the personality cults that the media seeks to build around them. They are diffident and awkward in public, and appear to writhe in the spotlight. Both parties grapple with massive issues, and draw on the work of hundreds in formulating policy, tactics and presentation. Yet these huge and complex matters are reduced to the drama of one person’s struggle. Everyone, in the media’s viewfinder, becomes an actor. Reality is replaced by representation.

Even when political reporting is not reduced to personality, political photography is. An article might offer depth and complexity, but is illustrated with a photo of one of the 10 politicians whose picture must be attached to every news story. Where is the public clamour to see yet another image of May – let alone Boris Johnson? The pictures, like the actors, blot out our view of other people, and induce us to forget that these articles discuss the lives of millions, not the life of one.

The media’s failure of imagination and perspective is not just tiresome: it’s dangerous. There is a particular species of politics that is built entirely around personalities. It is a politics in which substance, evidence and analysis are replaced by symbols, slogans and sensation. It is called fascism. If you construct political narratives around the psychodramas of politicians, even when they don’t invite it, you open the way for those who can play this game more effectively.

Already this reporting style has led to the rise of people who, though they are not fascists, have demagogic tendencies. Johnson, Nigel Farage and Jacob Rees-Mogg are all, like Donald Trump, reality TV stars. The reality TV on which they feature is not The Apprentice, but Question Time and other news and current affairs programmes. In the media circus, the clowns have the starring roles. And clowns in politics are dangerous.

The spotlight effect allows the favoured few to set the agenda. Almost all the most critical issues remain in the darkness beyond the circle of light. Every day, thousands of pages are published and thousands of hours broadcast by the media. But scarcely any of this space and time is made available for the matters that really count: environmental breakdown, inequality, exclusion, the subversion of democracy by money. In a world of impersonation, we obsess about trivia. A story carried by BBC News last week was headlined “Meghan closes a car door”

The BBC has just announced that two of its programmes will start covering climate change once a week. Given the indifference and sometimes outright hostility with which it has treated people trying to raise this issue over the past 20 years, this is progress. But business news, though less important than environmental collapse, is broadcast every minute, partly because it is treated as central by the people who run the media and partly because it is of pressing interest to those within the spotlight. We see what they want us to see. The rest remains in darkness.

The task of all journalists is to turn off the spotlight, roll up the blinds and see what’s lurking at the back of the room. There are some magnificent examples of how this can be done, such as the Windrush scandal reporting, by the Guardian’s Amelia Gentleman and others. This told the story of people who live far from where the spotlight falls. The articles were accompanied by pictures of victims rather than of the politicians who had treated them so badly: their tragedies were not supplanted by someone else’s drama. Yet these stories were told with such power that they forced even those within the spotlight to respond.

The task of all citizens is to understand what we are seeing. The world as portrayed is not the world as it is. The personification of complex issues confuses and misdirects us, ensuring that we struggle to comprehend and respond to our predicaments. This, it seems, is often the point.