Why There’s a Eurocrisis

It’s to do with payment systems.  Bear with me.

In the U.K., payments between customers of different banks, or the banks themselves, are handled through a system called CHAPS.  Briefly, what happens is this.  Bank A needs to send some money to Bank B, so they send them a message – a payment instruction.  This message gets copied to the Bank of England, with whom both A and B hold accounts.  The Bank of England debits A’s account and credits B’s; B then knows it has the money and can dispose of it as per the underlying transaction. So far so good.

Until the late ‘90s, the totting-up took place once a day, after close of play, it being assumed that the system was based on trust and the Bank of England would carry the can should Bank A not cough up– until some bright spark there woke up one day and said “erm, actually, we won’t.  Because they might break their promises, and we can't afford the consequences.”  Thus was born the system known as Real Time Gross Settlement, or RTGS.

RTGS says, in effect, that Bank A must be able to afford the payment at the moment it sends the instruction to Bank B.  In other words, it must have the money in its account at the Bank of England, there and then.  If it hasn’t, it must ‘post collateral’, which means pledging items of value, such as securities, against this debt.  In practice, payments tend to flow in both directions during the day between A and B (and there are of course the equivalent of overdraft limits before the need for collateral kicks in).  So it worked fine for years.*

Then, enter the Euro.  After a few false starts, they realised that they needed something similar, covering the Eurozone of seventeen countries, and after a few false starts they came up with a system which is an almost exact replica of the above, but with an extra layer added at the top – in addition to the Banks A, B etc. paying their national central banks (Bank of England equivalents), the national central banks would also need to settle with each other.  Obviously, this would be done through the central banks’ central bank, the European Central Bank (ECB).  The system they put in place for this is called TARGET.**

What they forgot, though, was RTGS.  Remember that?  Cash on the nail.  Of course, TARGET provides for this within each country – but there is absolutely nothing that forces the national central banks – the countries – to settle with each other at the ECB.  No totting up at all, ever, never mind payment by payment.  Oh, and no need for collateral either.  Just keep running up the debts – and dues– for ever. 

 

Which is exactly what has happened.  So now you know.  That’s why there’s a Euro crisis.  No recourse for broken promises.

 

If only they'd asked me at the time!

 

* I do wonder how it coped with the events of 2007-8. Hmm ...

** TARGET2, to be exact, if you want to Google it – the Wikipedia article is excellent, though it does require a bit of concentration.

Did the cheats get it right then?

I heard a pundit on the radio saying that the stability of the LIBOR rate over a long period should have raised suspicions, as it was out of kilter with the rates actually being traded in the market.  There’s a profound contradiction here.  If the markets were ignoring LIBOR, then what’s it for?  And if they weren’t, isn’t stability exactly what we’d all like to see?

Bretton Woods, anyone?

Bank Holiday

I think one’s overdue, don’t you?  But this time let’s big it up a bit. 

I don’t mean the sort of bank that looks after my money for me, pays my bills when I tell it to, keeps my diamonds in a safe, and charges me a reasonable, profitable fee for doing all that  (although there’s an unfilled niche market for one or two of those, it seems).  You know what kind of bank I mean.

On the news this evening, there was the entirely non-ironic juxtaposition, within minutes of each other, of the news of Barclays’(and, obviously, many others’) bent touts, under orders from their untaxed moral-free puppet-masters, having rigged fundamental market prices, over years – not just a rogue operative acting alone, even they recognise that one doesn’t wash any more – to their own benefit (and to the cost of the rest of the planet); and the fear that the forthcoming failure of the EU politicians, for the twentieth time (that’s not an exaggeration!), to sort out the so-called Euro crisis will (I quote) ‘panic the markets into hitherto uncharted territory’.

WHAT??  How much more of this sort of diarrhoea do they (I mean the Merkels, Osbournes and Diamonds) expect us to put up with? 

I have a modest proposal.  Shut down the capital markets, all of them, for say a fortnight.  Completely.  Worldwide.  Put all the touts on gardening leave.  And let’s see what difference it makes in the real world.  It’s not as drastic as it sounds – it seems to work on Sundays.

Burst Water Main - A Metaphorical Tale

At 11.30 a.m. on Tuesday, a mains water pipe at the top of the hill burst.  The water continued to flow –  an awful lot of it out onto the road, down the gutters and pavements, washing leaves and litter (McDonalds cartons, Tesco bags, lager cans, fag packets) down the hill, distracting small children on their way to nursery and scaring their mums, ending up (as water does) in a lake at the bottom, beyond the capacity of the already rather feeble drains, rat-running cars and vans having to steer round it.  This went on for a day and a night.

Once a team from the water company had turned up, closed the road and started up their drills and diggers, the flow, which had turned yellowish-brown by now, went down to a rill, then a trickle, then ceased, leaving a load of silt in the gutters and on the pavements.   By Friday, they had filled in their hole, re-opened the road and departed, leaving the silt behind.  Rat-run traffic got back to normal.  No long-term harm done.  The rain washed the silt away down the drains.

The above is all true.  What follows is made up.

Turns out that the reason the water main burst was that, in order to supply the new housing estate, the water company felt obliged to increase the pressure down the main, so that’s what they did.  But the housing estate was uninhabited, because the houses couldn’t be sold.  So the increased pressure had nowhere to go.  By a bizarre coincidence, everyone in the avenue happened to turn their mains taps off at exactly 11.30 on that Tuesday.  The pipe couldn’t cope.

The authorities knew that water companies are too big to fail.  They quickly installed even more powerful pumps at the top of the mains pipe, to ensure that this near-catastrophic supply failure could never happen again.  They also took measures to ensure that, if anyone should be silly enough to move into the new housing estate, they wouldn’t be able to afford water.  And they outsourced silt disposal to a newly-formed Russo-Chinese consortium.

Do The Default

I have solved the world's financial problems several times here since I started blogging, but my proposals - abolish the financial markets, everybody join the euro, and so on - have been totally ignored.  I can only assume that this is because they are not radical enough.  So it's time to take the velvet glove off.

Somebody recently asked (in the Guardian, of course): if practically everyone is in debt, who do they owe it all to?  Nobody came up with the obvious answer, which is 'each other'.  And nobody has yet explained to my satisfaction how the inverted pyramid of piss which seems to be causing all this trouble came about, or why anyone puts up with it.  On the radio only this morning, I heard an apparently important person, from a position of some authority, explaining in all seriousness that the problem was that governments were not doing enough to convince the markets that governments were doing enough to constrain the activities of the markets.  I simplify, but not by much.

So, let's all default on our debts.  Let's all - countries, corporations, families, people - say 'nope, sorry, can't repay you.'  What would happen then?  Susan from over the road would ask me to lend her £350 to buy a new iBrow or something.  I'd say 'fine, I'll just nip next door and borrow it from Crispian.'  Crispian would gladly say yes, because he knew that Kimberley two doors up would be good for it ...  We'd all be happy, because we'd know that we'd be welcome round Susan's place any time to play with her iBrow.  And the people who make iBrows would be perfectly happy.

Pretty soon everyone would get fed up with wasting all their energy whizzing money faster and faster around the planet, and hunker down to making and doing things that are actually useful to each other. 

Meanwhile, I can't even buy a decent cheese grater.  The company that used to make them has gone bust.

Undercooked shark steak

I haven't had a good rant for ages, and I feel the need for one, so it may as well be about banks.  And government.  And everything in between.

Bob Diamond, the newly appointed boss of Barclays, was hauled over the coals of a Commons select committee this morning, to be grilled on the hot topic of 'bankers' bonuses'.  Of course, the coals were lukewarm, and he didn't even get lightly char-broiled.  His people had, as one's people do, thoroughly prepared him for the inevitable questions from the viciously aggressive prawns of the committee, so he was able to say, with an apparently straight face, that there has been a period of 'remorse and apology' from the banks (WHAT??) but now we need to achieve closure and move on, and blah blah; and that he can't say whether or not he'll be renouncing his bonus this year because he hasn't yet been told how much it is (is that relevant?) and anyway he'll have to ask the wife (I'm not making any of this up); and, most barefacedly blatantly, that the invaluable contribution of the investment banking industry to the UK economy mustn't be overlooked and must be rewarded.

He was filmed afterwards leaving the committee venue, smiling coyly, as well he might. 

Why hasn't anyone (except me, but I don't count) suggested that these bonuses be in some way tied to what the beneficiaries claim to have done to earn them?  By that, I don't just mean how much so-called money they appear to have made, but how they did it.  Make the recipient justify it.  Reward good core activities like responsible lending, payment services - all the things we used to rely on banks to do - but don't, don't reward the kind of bubble-blowing that got us into this mess in the first place and seems poised to do it again.

But then, I'm just a shrimp amongst a sea full of raw prawns.  We don't stand a chance against the sharks, especially when we don't know how to cook them.

The financial crisis

a) It's not financial, it's psychological. We're told by the media that the markets zig-zag up and down due to things called 'confidence', 'uncertainty' and sometimes 'panic'. Other nouns and adjectives are sometimes used, but not to labour the point, we are never, ever, given units of measurement. Aside from some commentator's opinion, how am I to tell whether these operands (confidence, panic, etc) have in fact risen or fallen over a significant period of time (confidinans? uncertainometers? panicons?), and what is the algorithm, precisely, which links these unmeasurable determinants to the value of my bank account and shareholdings and the price or availability of bread or cheese in the shop? Precisely, please, anyone who knows. Until anyone can quantify and define the logic of this stuff, I'm sticking with my theory, which is that the people whose decisions determine these outcomes - financial market traders - are in fact mad. In other words, they conduct their daily activities according to a pattern (behaviours determined by perceived information within an assumed framework of logic) which bears no relationship at all to the real world, such as you or me going down the shop to spend some money.
b) The mechanisms. No-one has commented on this yet. The liquidity crisis, i.e. the ability of banks to lend to each other to cover short-term positions, at LIBOR, is governed by the real time gross settlement (RTGS) system imposed by the Bank of England in the late 90s to protect against intraday bank failures like the Herstaddt case back in the seventies. In the UK (I assume similar set-ups exist elsewhere) each member of the inter-bank network (CHAPS) for wholesale payments has to demonstrate, per payment and within defined limits, that they have sufficient liquidity (cash or collateral) to cover that payment, right now. If not, the payment gets scheduled back and has to be resubmitted later.

I'm a long-retired ex-banker who hasn't kept up with this stuff at all; but it does cross my mind that an easy way for the BoE to kick-start the liquidity freeze would be simply to raise the RTGS threshold to infinity (minus one). That way, every interbank payment, for whatever reason, would be guaranteed, and the money would start to move around again.