Βι¶ΉΤΌΕΔ

My credit crunch radar is bleeping with all kinds of worrying dots and they're mainly concentrated on the edges of Europe. There is Greece, its land borders currently blockaded by protesting farmers; there is Iceland, where protests last week brought down the government (for a valedictory interview with deposed prime minister Geir Haarde, click ); and now France, where a public sector strike has brought 300,000 people onto the streets of Marseille alone, and they're calling today Black Thursday.

If we dig into what's happening there are many layers. First, there is the austerity measures being introduced by governments. The ostensible cause of today's strike in France is pre-planned reforms to the school system and job cuts among teachers; but it's brought students to occupy their colleges, car workers, rail workers - and its fanned by a generalized discontent about the way Sarkozy is handling the credit crunch.

The second layer of problems Europe faces concerns the East European banking system. Though most of the stricken countries are outside the Eurozone, there are some big Eurozone country banks exposed to the near collapse of east European banking - above all in Austria. A coalition of banks led by Austria's Raiffeisen and the Italian giant Unicredit has said they may have to stop lending both to governments and companies in the Balkans. They are pleading with the EU for financial support. In the Baltic States and the Balkans the banking system is dominated by subsidiaries of these Eurozone owned banks. What analysts fear as a worst case scenario (why am I using this phrase a lot right now?) is that a banking collapse in the east pulls the Austrian banking system down with it.

The third tier of crisis concerns the Euro. The EU's commissioner for economic and monetary affairs has said today that the Eurozone "will not break apart" because of the stresses on its weakest currencies. But the question is being asked.

The reason is the growing "spread" between the interest rates governments have to pay to borrow on the international markets. Theoretically, beause they're all part of the Eurozone, they should have the same interest rates. But it's always been slightly divergent and now massive gaps have opened up.

Greece had its credit rating downgraded on 14 January; Spain lost its AAA rating last week. Portugal has also had its rating cut. As a result these countries have to pay significantly more interest on their sovereign debt compared to the baseline country, Germany. Ireland is in the same boat. What this means is that, although there's a single currency, there is a differential risk of a sovereign debt default, a different interest rate for government borrowing and so, in the fullest sense, there is not really a single currency.

It's prompted my colleagues to ask me (why me?) why the Brits are not revolting in concert with their European counterparts. I will give you three reasons:
1) There's no austerity drive yet because the government has decided to borrow its way past the next election. The austerity will come later.
2) The fall of sterling against the Euro allows Britain not only to export more but to let steam out of the system that the pegged Euro countries cannot.
3) They are protesting, but mainly about Gaza (also Heathrow and, sign of the times, migrant labour in East Anglia). This is relevant because the Greek protests, as is widely acknowledged, started over a killing by the police, and have now rolled over into agricultural subsidies and the general handling of the crisis.

Due to the Βι¶ΉΤΌΕΔ's rule about not sending zillions of people to the same event, I am not at Davos this year. However I can share with you highlights of today's programme.

7am. Pro-am Celebrity currency policy snow wrestling: Tim Geithner vs Wen Jia Bao.

9am. Aideed Valu, CEO of major consultancy firm reveals startling insight that tough times bring out the best in corporate global leadership.*

11am. Gordon Brown hails the birth of a new global order. Nouriel Roubini predicts 10 year slump.

12 noon. How the crisis is pushing a billion towards starvation in the developing world. Various religious leaders and celebrities in conversation.

1pm British themed Lunch. Whitstable Oysters (Protected Geographical Indicator); Scotch Beef (PGI) Jersey Royal Potatoes (Protected Designation of Origin). Kentish Ale (PGI) Dorset Blue Cheese (PGI).

1.30 Discussion. Why we must avoid trade protectionism at all costs

2pm David Barcode, CEO of major supply chain management firm gives seminar: tough times mean only those who automate their supply chains will survive.

3pm Keynote: Vladimir Putin (please bring a torch to this venue and dress warm as the lighting and heating have been playing up)

3.20 Optional flight to Zurich for delegates' to make fact-finding tour of private banking district.

* For the ironically challenged I will point out this is meant to be a spoof.

Shortly after Labour's 2005 election win I was summoned to a speech by Tony Blair, hosted by the IPPR. It was entitled Risk and the State and naturally induced as much anticipation as a crown green bowling telethon.

However, halfway through I realised Blair had said something that sounded calculatedly outrageous: that the Financial Services Authority was "seen as hugely inhibiting of efficient business by perfectly respectable companies that have never defrauded anyone".

The implication was that finance was over-regulated, the FSA over-heavy, and that it should be essentially a policeman dealing with criminality, not a surveillance body dealing with systemic risk.

This is the same FSA that has, implicitly, been drubbed by its new boss, Adair Turner, for its failure to adequately monitor the financial system as it careered out of control in the first half of this decade.

At the time, the then boss of the FSA wrote a furious letter to Blair, accusing him of undermining the FSA's role. Had not the FSA been at the forefront of the drive for light-touch regulation in Europe, McCarthy complained, and now it was being dissed as heavy handed.

We don't know how the spat ended because Tony Blair's reply to this letter has been suppressed under the Freedom of Information laws. What we do know is that the FSA was under political pressure from the Labour government to be even more hands-off than it already was.

If this sounds a bit Orwellian then the whole current episode has the air of that famous moment in Nineteen Eighty Four where the enemy suddenly switches from Eastasia to Eurasia, without anybody daring to comment.

Let me quote extensively from (which I recommend you to read in full as its analysis is trenchant and heavily influenced by those economists who locate the savings glut in the malformed structure of the global economy):

"The FSA has been more open than I think any institution involved in this crisis in admitting that it made mistakes in the institution specific supervision of Northern Rock. But I think the best judgement is that better institution specific supervision of Northern Rock, would have made only a very small difference to the shape and impact of this global crisis.

"The far bigger failure - shared by bankers, regulators, central banks, finance ministers and academics across the world - was the failure to identify that the whole system was fraught with market wide, systemic risk. The key problem was not that the supervision of Northern Rock was insufficient, but that we failed to piece together the jigsaw puzzle of a large UK current account deficit, rapid credit extension and house price rises, the purchase of UK mortgage backed securities by institutions in the U.S. performing a new form of maturity transformation, and the potential for irrational exuberance in the market price of credit. We failed to realize that there was an increase in total system risk to which financial regulators overall - authorities, and central banks and in fiscal authorities - needed to respond."

Now, who is "we" in this "wea culpa"? Clearly Lord Turner's predecessors at the FSA, Calum McCarthy and John Tiner. In addition, Mervyn King the governor of the Bank of England. Also the people who designed the tri-partite regulatory system: Gordon Brown, Ed Balls and Gus O'Donnell. Once you put names to this "we" it reads as a very strong criticism of the Labour government and its chosen regulators.

Both the Bank of England and the FSA have the statutory responsibility to maintain financial stability. They failed. The statutory responsibility was conferred on them by the Treasury. It, by implication failed.

There is a legitimate question: why? I will answer it with another question. Is it because the whole world of banking regulation and supervision is in fact a closed club populated by former bankers? Is it because the politicians were too starry eyed about the bankers? After all the rise of global finance delivered seemingly endless growth, and lots of tax revenue to plough back into the lower reaches of society in the form of tax credits and benefits. Was this apparently win-win situation allowed to cloud the judgement of the politicians and regulators?

If, now we are in sackcloth and ashes phase, you came across a politician who made a speech saying the banking system was at the beginning of a "golden age", just months before the collapse, you would want that politician to answer some questions raised by Lord Turner's lecture. Not just for the sake of drawing a balance sheet but to make sure they had got the message that the whole deregulationist philosophy is over. The "golden age" epithet was, of course, uttered by .

I will leave you with the quote in full.

"So I congratulate you Lord Mayor and the City of London on these remarkable achievements, an era that history will record as the beginning of a new golden age for the City of London....And I believe it will be said of this age, the first decades of the 21st century, that out of the greatest restructuring of the global economy, perhaps even greater than the industrial revolution, a new world order was created."

And another question: the government has just been hammered in the courts over the Equitable Life case, on the technicality that, for a few short months, it was the regulator (during the transition to the FSA). In the case of our financial meltdown, if it is now "official" that the regulatory authorities failed in their duties, both in detail over Northern Rock and systemically, does anybody who lost money have a legal redress?

Just a thought.

Okay, here in a very few, sketchy lines, is what is going on while the world (including Newsnight, just for one day!) is distracted by the Obamathon.

Problem One: There is substance behind the rumours that the UK sovereign debt is about to be downgraded. That is, there is both market logic and evidence that the markets are treating the UK debt as non AAA. Economist Graham Turner writes:

"Spain lost its triple A credit rating from Standard & Poor's yesterday. The country's long-term sovereign debt was downgraded because of the deteriorating public sector finances. But if Spain can get downgraded, then the risks for the UK are self-evident."

"The latest UK public sector net borrowing shows a shortfall of Β£62.4bn in the year to November, up from Β£35.6bn in FY2007/08. The full-year total looks set to reach Β£90.0bn, which would broadly equate to the deficit likely to be seen in Spain. But the UK has an added problem. Its liabilities outstanding are rising faster as a result of the banking bailouts."

Problem Two: Even with my fair, balanced, impartial and totally compliant with the post Russell Brand Βι¶ΉΤΌΕΔ rules hat on, I cannot find any other adjective to use about the position of RBS than "unsustainable". But that is not the real problem. . There is no evidence that this is correct, but Barclays, since the 25% share price fall on Friday, are clearly on the Treasury/FSA/BoE radar. It is clear that Gordon Brown believes he was misled by RBS at some stage. Therefore, as a man who will only ever have to go to his own source of funding once (i.e. the electorate), he is once bitten twice shy.

Barclays meanwhile has provided loads of evidence that this is not the case. It is claiming a 9.5% Tier One capital ratio, which would allow it to write off Β£20bn while remaining compliant with its regulatory capital ratio. [UPDATE, this is a change from the first draft which was a bit over-optimistic on my part]. Of course Barclays cannot give us the one figure we all need: how much of its Β£420bn loan book is bad. Meanwhile, the influential website is running the headline: "Is the UK's Financial System Technically Insolvent"

Problem Three: Ireland's finances now looking very perilous. What happened was that late last week in Tokyo, Irish PM seemed to say the country was on the brink of an IMF bailout:

This sent the interest rates on Irish government debt soaring. Now, at either end of the Eurozone you have countries whose creditworthiness is crumbling (Greece is in an even worse position). All across the continent there are op-ed pieces about whether one or other of these countries could actually bail out of the single currency.

All this is not directly a problem for the UK, but it shows that country debt is now the next big battleground for the forces of destruction unleashed by the credit crunch.

Problem Four: , though comprehensive in design, has not been readily "believed" by the markets. The plunge of RBS is one signal. The general weary response of the broadsheet press is another, together with seasoned City insiders like Howard Wheeldon, who writes this morning:

"The underlying fear though is also a reflection that the government is continually turning a blind eye to the relentless rise in national debt to hitherto inconceivable levels and the cost of this burden of this in the years to come could extend this period of recession over many years. Equally it is fear that gilts are already under pressure and that the whole system by which the government borrows to fund debt may be unable to cope meaning that at some point we might be building up to a repeat of 1976 when the IMF had to be called in. It is many other things too such as fear that even if the government is soon driven to call a general election with such an appalling inheritance what better chance does any new government have of clearing the self induced mess up."

Problem Five: Yesterday's bailout was clearly the work of some very smart cookies doing joined up policy: to get the FSA, Bank of England and Treasury ducks in a row is hard at the best of times. However, it demonstrates that huge amounts of government energy are going into firefighting rather than new system design or even pro-active policies to dig the real economy out of this mess. If you compare and contrast the current efforts to those of Obama they are striking. Obama has where, apart from the emeritus sounding chairmanship of Paul Volker, he will put his radical Chicago-trained economists to work to engineer the $1bn job creation plan - which he seriously believes can create 3-4 million jobs by 2010. By contrast, Britain's fiscal stimulus knocks about 20 quid off a new laptop if you have money enough to buy it. And that's it, apart from the internship and apprenticeships.

The atmosphere around Whitehall and the press is febrile: we always seem to be on the brink of some major financial disaster, about which only a select few people seem to have any inside knowledge. I think, as well as all the tangible things like losing your job, getting your credit card declined etc, that is what's really going to wear thin with people if it doesn't end soon.

Here's what I've gleaned about the bailout the UK government is set to launch on Monday morning. There are two elements, the long-touted insurance scheme for toxic debts, and a range of measures to free up sources of funding for banks.

Significantly, the government will not be announcing a fully fledge asset insurance scheme, as trailed in various papers. It will announce the principles and then "if the banks are interested" they will be negotiated with on a case-by-case basis I've been told.

Frankly, what I surmise from this, is that the much hyped discussions with the banks this weekend have not produced agreement. If there was industry-wide agreement on a bad debt ringfencing scheme it would have been announced tomorrow. Also, clearly, there is no "bad bank" going to be set up for the taxpayer to buy toxic assets.

The more interesting aspect of tomorrow therefore looks to be a raft of new govenrment guarantees on funding. The Crosby report recommended the taxpayer underwrite new mortgage issuance, and Darling accepted this in principle. If, as I expect, this is announced concretely tomorrow the question is, does the UK get an activist, publicly controlled mortgage originator as per Fannie Mae, or a "power". If it is the latter, who wields the power and do they do press interviews is my first question?

Anyway there you have the latest: no bad bank, no industry-wide insurance scheme but a commitment to provide asset insurance to any bank that wants it, and a far-reaching but unspecified provision of further billions of funding sources. Clearly, the taxpayer exposure involved in all this will need to be calibrated.

I think we need to see the details of Bailout MkII before saying anything more: they will be complex. I will try to unpack them on Newsnight tomorrow night, which will mean junking a long-planned feature on the economic legacy of George Bush. See you at 1030pm GMT Monday.

UPDATE: It seems the government will also up its stake in RBS, as reported in the Telegraph. We are now looking at owning 70% of the bank's shares (compared to 60% before).

I must, first, apologise for the long gap between my last blog posting and this one. I've been finishing off a book about the credit crunch and trying to write about the same subject in two different genres at once was too much for my brain.

But the book's finished, just in time for Round Two of the financial crisis, which opened on Thursday with the nationalisation of Anglo Irish Bank. Yesterday (Friday) we saw both Bank of America and Citigroup announce huge Q4 losses, and BoA get bailed out to the tune of $130bn.

The significance of this is that, back in September, both BoA and Citi seemed like part of the solution, not part of the problem. BoA chivalrously bought Mama Merrill, while Citi offered to buy the failed high-street bank Wachovia. Even back then it was obvious they were going to be victims of the crisis themselves - indeed victims is the wrong word: Citi alone was responsible for 25% of all "structured investment vehicles" in the shadow banking system at the time it collapsed.

And then, at precisely 1500 GMT, another "solution" bank, Barclays, saw its shares collapse by 25%. (Barclays remember bought part of Lehman and even looked at buying Merrill on 14 Sept). BARC's shares have lost 45% on the week, 80% on the year. The reason is (a) short selling was unbanned in Britain yesterday and (b) Barclays has repeatedly sprurned government cash in the bailout phase, going to the markets instead and in the process diluting the value of existing shares. Yesterday's collapse was prompted by the knowledge that another round of bailouts is a-coming, and by a boardroom scrap that saw deputy chairman Sir Nigel Rudd resign. The rumour (denied) was that the scrap concerned the way Barclays was valuing certain assets on its balance sheet.

Anyway, all that is just a hors d'ouvres for what is to come. Right now UK Treasury officials are at work on several overlapping schemes to try and re-bail-out the banks. Clearly the Β£37bn the taxpayer put in in October only worked to stabilise them; as all know, they took the money and decided that they would henceforth lend little, and at high interest rates, while taking as many deposits as possible at very low interest rates. This has hammered both borrowers and savers to the point where it is hardly worth doing either activity; as both borrowing and saving are crucial activities for the functioning of a capitalist economy, and banks - as we all learn in school - are there to encourage this, it's a bad situation.

But it's about to get worse if somebody does not do something...

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