Deutsche Bank: A Vertically Integrated Problem

Recent concerns about Deutsche Bank’s financial position highlight again that banking remains fragile. On Friday Deutsche Bank’s shares fell nearly 9% at the opening bell as investors panicked about news that hedge funds had started to pull business from the company.  This comes off the back of increased concerns about potential writedowns and the vulnerability of its coco bonds at the start of the year.

The immediate trigger for this most recent panic is a $14bn demand by the US Department of Justice to settle allegations related to the mis-selling of mortgage backed securities & CDOs during the 2000s boom. This comes after several other large banks settled similar cases with the DoJ: Bank of America paying a $16.65bn settlement for activities undertaken by it and its subsidiaries including Merril Lynch and Countrywide Financial Corporation, JP Morgan paying $13bn and Citigroup  $7bn. In some cases the fines eventually paid were significantly less than the original sum demanded by the DoJ. There is hope within Deutsche Bank that a similar deal can be struck and a lower amount paid, with recent estimates venturing that the figure could be closer to $3-4bn.

But Deutsche Bank’s bargaining position with the DoJ may be hampered by the specific detail of its activity in RMBS and CDO markets during the boom. Unlike US banks, Deutsche Bank ran a more vertically integrated model of securitization (Exhibit 1) which meant it occupied a different space in the market compared to its competitors. By integrating trustee, listing and other administration functions (which are provided by external parties in most US CDOs) the DoJ will have to consider whether Deutsche Bank’s larger footprint potentially gave it a knowledge advantage.

Exhibit 1: Deutsche Bank entities co-participation in CDOs. Line thickness = #of joint products (values given); size of node = #of CDOs involved with.

To illustrate the point, with the STAtic CDOs that featured heavily in the Senate report on the causes of the financial crisis (373 f. Footnote 1505), either three or four Deutsche Bank entities were usually involved in their structuration: DB’s Irish Deutsche International Corporate Services Ltd., its Cayman Deutsche Bank (Cayman) Ltd., its American Deutsche Bank Securities Inc., Its Luxembourgian Deutsche Bank Luxembourg S.A. and Deutsche Bank (Exhibit 2). These positions were mainly occupied by independent providers in the case of US bank CDOs. Not only that, but Deutsche Bank also sold these services to other market participants (Exhibit 3).

Exhibit 2: Deutsche Bank entities involved in START CDOs 

Exhibit 3: Comparison between Deutsche Bank entities and other major US banks involved in the CDO market

The DoJ will have to consider whether Deutsche Bank’s vertically integrated model gave it access to more information about the quality of the due diligence and thus the underlying collateral in the CDO market. If it believes Deutsche Bank’s structural position meant its employees did know more than their competitors, then - given the febrile context - it might now be financially prudent to consider jail time for the individuals involved rather than fines for the institution. 

Stanley & Tatu.

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Tactics Without Strategy: Brexit And The Politics Of Conceit

With two million Conservative voters seemingly ‘undecided’ last week and Labour voters preponderantly pro-Remain but susceptible to no-shows at the ballot booth, it was tempting to presume before the vote that an event of this magnitude might be decided by something so quintessentially British as the weather. Come Friday morning, it was abundantly clear that was not the case. The gap between Leave and Remain was just under 1.3 million votes, far greater than can be explained by a June downpour. The outcome is humbling.

In due course the referendum defeat will become the textbook reference for political hubris. Cameron’s referendum campaign showed a fundamental underestimation of public mistrust with the political establishment when it committed taxpayers’ money to the production of Remain leaflets. Similarly an appeal to the eminence of its leading voices on the risks of Brexit – prescient though they were – might work when it comes to winning over fearful middle class swing voters in marginal seats, but alienated a large and sceptical cohort who had not done particularly well since the 1990s. This played to Leave’s strengths who were only ever going to run a populist campaign with immigration as the issue ‘the establishment wouldn’t touch’. The more establishment figures Remain wheeled on, the more remote they seemed.  

The referendum loss symbolises Conservative leaders obsession with tactics at the expense of strategy. They built a machine to be elected not govern, perfecting the art of winning small political skirmishes which embrangled them in increasingly intractable commitments. Eventually one intractable position was not going to hold.

So where does the referendum result leave things? Economically, we are in a difficult place. The EU will push for an early exit to reduce uncertainty in other EU countries. The longer negotiations are drawn out, the more turmoil will be inflicted on our major trading partners within the EU - there is a good chance they may move into recession, as seems unavoidable for the UK. It is sadly true that they also must make an example of us or risk giving hope to Leave movements elsewhere. Investment, already weak, will retreat until some certainty returns. This is happening in real time, with huge swathes of construction now put on hold. Financial markets are not as robust as we are led to believe and the £250bn injection promised by the Bank of England - presumably a bid to stave off a prospective wholesale run as bank stocks fell 30% – would seem to support that. We have yet to see the effects of a ratings downgrade and sterling devaluation on the economy. It is doubtful that the devaluation will benefit the export sector radically: in four of the last six major periods of devaluation there has been no impact at all. These are not the conditions under which the politics of optimism thrive.

This takes us to the Leave campaign. The campaign was built on an anti-establishment/anti-intellectual ticket led by an old Etonian and another Oxford graduate. It traded on the conceit that many of the UK’s problems could be solved by ‘taking back control’ – an organising metaphor abstract enough to galvanise a body of voters with quite different perceptions about what this meant. The usual accusations about Leave being ‘old, uneducated people in the North’ have already surfaced but the reality is much more complicated: 43% of ABs voted Leave, for example – that’s a lot of skilled workers and professionals. Similarly, the geography of the Leave vote is split between cosmopolitan centres like London, Bristol, Manchester and Liverpool on the one hand and smaller towns and rural areas on the other. The most important indicator of a Leave voter is value-based according to Ashcroft’s polling data: in other words, we are witnessing the reawakening of a particularly cynical, conservative English authoritarian personality which cuts across class and geography. ‘Taking back control’ in this context signalled a variety of things: release from the EU’s institutional sclerosis and immured power bases; rejection of the neo-liberal grip on policy formation; devolution and an improvement in accountability and sovereignty. But for many it primarily meant control of immigration. And the Leave campaign was happy to let people believe that this was precisely what we were voting for.

The problem now is that this puts Johnson and Gove in precisely the predicament of Cameron and Osborne.  The latter were outmanoeuvred tactically, but it is Johnson and Gove who have the larger strategic quandary. The flipside of the Leave campaign’s amorphousness is that all of its voting tribes will expect their vision of Brexit to be delivered: that is the risk with summonsing ‘end-of-truth-and-reason’ politics. Putting aside the inconceivability of honouring the £350m per week to the NHS pledge, they have a much larger problem regarding immigration. If they opt out of the pledge to stop free movement, as pro-Leave campaigner Daniel Hannan has already indicated, those who voted Leave believing it was a vote to control immigration will feel betrayed.

This is ultimately why I am pessimistic. If you lead a populist, anti-immigrant campaign on an anti-establishment platform, and then support an EFTA model that retains free movement, you will discredit yourself and the democratic process. Add to that a rapidly deteriorating economic climate and the resurgent nationalism you were complicit in stoking, and voters will begin to embrace the extreme right. It will take considerable political skill for Johnson and Gove to manage this next phase should they replace Cameron and Osborne. I am not sure it is within their capabilities. Both have a facility with the blunt instrument of populism, but they do not possess the political guile and sophistication to deal with the subtle intricacies of a perceived volte face in such a febrile climate. Farage, however, does have the necessary nous and aggression to point out their deceit.

Can the Left stop this? They are in a difficult position, not least because we are seeing the working out of the legacy of New Labour - its mishandling of the financial crisis and intransigence towards its heartlands. This instilled a sense of injustice, of powerlessness, of being cut adrift. Atavism fills the space left by the dismantled social and economic institutions that build solidarity and community. The Labour Party were correct to move to the left to reconnect with those communities as voters began to defect to UKIP, but they have the wrong leader to deal with the fight to come. The Labour Party needs a brawler, not a history teacher.

Whoever that might be, they will need to address some of the profoundly reactionary sentiments of their ex ‘core vote’. Anti-immigration is now a deeply ingrained and increasingly animating ideology that will be difficult to reverse. A politics of trust, tolerance and understanding to support vibrant communities of difference is needed. This requires a redistributive politics to fund the rebuilding of the economic and social institutions that embed harmony: better jobs, better public services, better social housing. That may grate with the business elites of London and other cosmopolitan centres, but social dislocation is not good for trade and growth either. As Duncan Weldon has pointed out: capitalism needs social democracy to function. The state now has a duty to stabilise capitalism by acting against the interests of its most vocal proponents and greatest beneficiaries. This is the challenge for Labour.

Stanley

Panama Leaks In The Context Of Austerity

I always thought the austerity rhetoric had something of ‘the spirit of the Blitz’ about it. Austerity (the rhetoric) instilled a sense of togetherness and inclusion in the British public even if austerity (the programme) had a highly uneven impact on different groups, and was largely ineffectual in improving our country’s economic fortunes. In a country steeped in nostalgia for the Second World War, this kind of appeal to mass public sacrifice had a galvanising effect. The British public accepted the idea that some personal short term pain was necessary, even if they privately wanted to see more of that pain passed on to those they deemed less deserving. It conjured images of rationing, of a British public without heed to class distinctions responding stoically to a time of crisis - we were ‘all in it together’, showing our unity and our mettle in times of adversity. Even our cultural artefacts said ‘Keep Calm And Carry On’, before the Hoxtonistas got their hands on them.

It is perhaps because of the success of austerity (the rhetoric) that the Panama leaks are so potentially damaging. The unpalatable situation that confronts the Conservative party this morning is that at the time David Cameron announced the absolute necessity of austerity to UK citizens, his father had employed the services of Mossack Fonseca to avoid making the sacrifices perceived to be the duty of others less well off than himself. Time will tell if Cameron stood to gain personally from this arrangement, but it is now difficult to avoid the sense that we were never all in it together: it was always one rule for the privileged and another for the disabled, the homeless, the council workers, the nurses, the junior doctors and multiple others who were told that there was no alternative and that we all must give up something for the sake of the many. For a party steeped in family and other money, much of which may prove to be mobile, there will be nervousness amongst Tories tonight because that image is potentially toxic.

The British electorate do not like hypocrites and they don’t like to be taken for fools. It was, after all, the hypocrisy of the Back To Basics programme that undid the previous Conservative administration, as revelations about extra-marital affairs, romps and exotic sexual encounters undermined the party’s authority to wag its finger at ordinary people and preach the merits of self-discipline and the sanctity of the family unit. The routine scandals made the party a laughing stock and robbed them of power for nearly a generation. We are now potentially in Back To Basics Mark II. When asked to make sacrifices, we like to think it is not beyond those who stand to lose least proportionately to muck in; particularly when the financial crisis was in large part an elite debacle in the first place. What we learn from the Panama leaks is that for the rich, including allegedly a relative of our leader, even these modest sacrifices were unacceptable.

Cameron has said that this is a private matter, but it cannot be this time. The context of his own austerity rhetoric makes this new revelation unavoidably public. This can’t be handled like the pig-gate affair which was successfully starved of oxygen; his one-line response is of similar intent. Cameron now stands accused of something much worse: he is accused of being a hypocrite and of taking the British public for fools. And that is much more serious politically.

Stanley

The End Of The Experiment? Part 1

Our new book, The End Of The Experiment? From Competition To The Foundational Economy  is now available  as an ebook on Kindle. Over the coming weeks we will be outlining its argument and we begin here with a sketch of the historical and intellectual context of the work.

The British economy has been in relative decline since the last quarter of the 19th century, and there has been debate about the sources of that decline since at least the great ‘national efficiency’ debate prompted by the failings revealed by the Boer War.  Britain, it seems, is the subject of eternal experiments. In the post-war years there have been two. The first was the post-war settlement, which delivered historically unparalleled prosperity and generous public goods in the form of the welfare state. That settlement floated on the ‘long boom’ (the thirty glorious years) and it sank alongside that long boom in the 1970s. For over thirty years now we have lived through a new experiment, symbolically inaugurated by the victory of Thatcherite Conservatism in 1979, but an era of experimentation which also encompassed the heady years of New Labour domination. That experiment had several well known features.  It created ‘flexible’ labour markets;  it dismantled the command economy represented by publicly owned industries;  it placed a bet on the creation of a ‘branch’ economy in manufacturing in a global division of labour, and on a financial services revolution in London; it prompted an outsourcing revolution which saw numerous public services franchised to private corporations; it created an audit state; and it ushered in a new era of micromanagement by the Whitehall elite.

The starting point of our book is the failure of this latter experiment.  The public occasion of failure was the great financial crisis, but the roots lie much deeper.  Our book explores four great deficits left by the thirty year experiment:

• A competitiveness deficit: productivity stubbornly lags behind our competitors; the financial services sector  has failed to generate employment; and ‘branch’ manufacturing  has failed to solve the problem of the trade deficit.
• A sustainability deficit: the post-war settlement delivered generous public goods; we show (for instance  in our broadband chapter and in the separate studies of the rail industry carried out in CRESC) that the privatised system isn’t delivering a sustainable infrastructure.
• An accountability deficit: the thirty year experiment was legitimised in the language of accountability, but it has created new worlds of unaccountability – out of control corporate elites, franchises in privatisation and outsourcing shrouded in opaque accounting, constant uncertainty about accountability lines between politicians and service deliverers.
• A competence deficit: the age of experiment has also been  a new age of fiasco -  outsourcing, PPI, rail privatisation, financial regulation; a hollowed out civil service unable to police the new franchises.

The metaphor of an experiment has an appealing ring: experimentation is, after all, the standard method by which the sciences learn, by  testing, refuting or confirming theories. But the British history of experimentation is very different: we show in the book that we live in a state that finds learning from experience very hard. There seem to be three political reasons for this:

‘Hyperpoliticisation’: in a world of extreme micro-management everything is turned into adversarial politics and what in the book we call the ‘antidote fallacy’

The closing of the metropolitan political mind: a drastic narrowing in the social and institutional range of elite recruitment (symbolised by the disappearance of the mass political party and domination of  politics by a narrow class of  professionals) is part of the problem; an equal problem is the rise, since Thatcherism, of a ‘TINAF’ mentality: There Is No Alternative Framework, and this drastically  narrows  the range of possible dissent from the official ‘line to take’.

The shrivelling of professional expertise.  Thirty years of centralisation and increasingly tight control of professional elites have left  (beyond devolved government) shrivelled alternative institutions in civil society  - and alternative sources of ideas.

We will develop these themes further over the next three blogs.

Manchester Capitalism

Boris Johnson: Cheer Leading For Inequality

When he gave the annual Margaret Thatcher lecture Boris Johnson’s praised inequality in a calculated way. He was positioning to challenge the Tory leadership from the right, if and when Cameron and Osborne fail to increase Tory seats at the next election.

Perhaps in an attempt to block Johnson’s manoeuvring, George Osborne, in a softer way, repeated those sentiments in his comment on Johnson’s lecture: inequalities of outcome are inevitable; the important thing is to ensure equality of opportunity through schooling:

"I think there is actually increasingly common agreement across the political spectrum you can't achieve equality of outcome, but you should be able to achieve equality of opportunity… You should give everyone, wherever they come from, the best chance, and, actually, education is the key to this."

This is partly wishful thinking when schooling in so many ways reinforces inequalities driven by catchment areas and the residential segregation of different income groups. But the more troubling point is that the Tory Right are now trying to break with the Westminster consensus in several ways.

First, the five Tory back benchers who wrote Britannia Unchained have blamed our lazy workers for continuing underperformance: “The British are among the worst idlers in the world. We work among the lowest hours, we retire early and our productivity is poor. Whereas Indian children aspire to be doctors or businessmen, the British are more interested in football and pop music”.

Now Boris Johnson praises the deserving rich who are smarter so that they will inevitably succeed against the masses who, on his account, have low IQs not a deficient work ethic. Johnson presents us with the cornflakes pack account of social reproduction and income inequality:

“Whatever you may think of the value of IQ tests, it is surely relevant to a conversation about equality that as many as 16 per cent of our species have an IQ below 85, while about 2per cent have an IQ above 130. The harder you shake the pack, the easier it will be for some cornflakes to get to the top”

This analogy rests on a farrago of unjustified assertion about competitive struggle, half-truth about the contribution of the rich and sleight of hand about the IQ evidence topped off by a failure to distinguish between income and wealth inequalities.

1. Johnson’s whole argument is framed  in a familiar way by the assertion that our country and individuals within it are all engaged in ceaseless, striving competition:

  “Like it or not, the free market economy is the only show in town. Britain is competing in an increasingly impatient and globalised economy, in which the completion is getting ever stiffer. No one can ignore the harshness of that competition, or the inequality it inevitably accentuates; and I am afraid that violent centrifuge is operating on human beings who are already very far from equal in raw ability, if not spiritual worth.”

This is really a quite peculiar perception which hardly fits the facts. The balance between internationally exposed and sheltered activities in Britain has been decisively changed by the competitive failure of British tradeable goods. Real manufacturing output has not increased in the past forty years and manufacturing now accounts for no more than 11% of GDP; our export success is narrowly concentrated in financial services from London finance whose activity brings public risks as well as private rewards.

Johnson’s argument completely ignores the sheltered “foundational economy” of private and public organisations producing everyday goods and services. Pipe and cable utilities, transport infrastructure, food processing, supermarkets, health, education and welfare altogether now employ 40% or more of the workforce. In these sectors, pay relativities and minimum wages are not determined by competition from Guangdong Province but are a result of social choices intersecting with business models

2. Johnson tries to legitimise income inequality by making disputable claims about how “the rich” contribute to society through paying taxes.

“ When Margaret Thatcher came to power in 1979 they ( the rich) faced a top marginal rate of 98% and the top 1% of earners contributed 11% of the government’s total revenues from income tax. Today, when taxes have been cut substantially, the top 1% contributes almost 30% of income tax, and indeed the top 0.1%- just 29,000 people- contribute fully 14% of all taxation. That is an awful lot of schools and roads and hospitals paid for by the super rich”

We‘re fairly sure the 30% figure exaggerates the contribution of the rich. A quick google  search highlights a BBC story from 2009 which suggests that the figure is below a quarter for the top 1%. The 30% figure does not come from any kind of academic source since but seems to have been put into circulation by a stockbroking firm Oriel Securities which explicitly says it is doing “non independent research which constitutes marketing communications “

And the 30% of taxes claim represents the same sleight of hand as in the old trade narrative about London finance’s contribution which we dissected in our Alternative Banking Report of 2009. London finance highlighted its 30% contribution to corporation tax and ignored the fact that its contribution to all taxes paid was half as large and a sector like manufacturing paid more. So it is in this case where Boris Johnson highlights share of income tax without discussing the broader picture. Mrs Thatcher did not reduce state expenditure’s share of GDP, but cut income tax rates and shifted the burden of taxation onto regressive consumption taxes. So the share of all taxes paid by the rich is much lower than 30% and it is the poor and middle income groups who are paying for their own schools and hospitals

3. Johnson’s category of “ the rich” conflates inequality of income and wealth; if we dis-aggregate the two groups, the relation between IQ and income is positive but the relation between IQ and wealth is almost certainly non existent

Here is a standard sociologist’s take on the correlation between IQ, income and wealth. 

There is a loosely positive correlation between IQ and income, but it is not immensely strong. That is because, for example, there are many examples of institutions which pay modest wages to high IQ individuals – public universities being one good example. But the more interesting finding is that the correlation between IQ and wealth is completely absent. And the obvious explanation for that is because wealth is inherited without conditions as to intelligence, diligence or anything else.

Inherited wealth is the big problem for the new social Darwinists like BoJo. Not least because the past 30 years of widening income inequality will be followed by congealed wealth inequalities because the rich cannot easily be prevented from having children who will often be dim scions. These inevitabilities would be best addressed by a system of death duties and inheritance tax which (unlike the present regime) could not easily be dodged by setting up a family trust.

The fundamental problem is always the economic and social reproduction of inequality. But that is always invisible in Johnson’s discourse.

Dyfal Donc and Stanley

The Banking Crisis As An Elite Debacle – Again.

The troubles of the Coop Bank remind us that crisis and fragility are still engrained in the banking system.  Evidently setting things right is about more than finding a technocratic fix.  That just confirms the results of arguments already in the public domain by researchers from CRESC and associated with Manchester Capitalism

Another month, another banking scandal, and another round of the blame shifting game.  The Reverend Paul Flowers must now be on Fred Goodwin’s Christmas card list: he has replaced Goodwin as the nation’s  favourite demonised banker. Since he does not have a knighthood of which he can be stripped we must wait to see whether the Methodist Church  ritually unfrocks disgraced ministers; or perhaps he will be stripped of the Institute of Bankers Part 1 Diploma which he gained in the 1970s.  All the manoeuvring between the regulators and the parties to shift blame for the Cooperative Bank fiasco brings a strong sense of déjà vu, a rerun of what happened after the great banking crisis of 2007-9.  Like modern Bourbons the financial elite and its political allies have learnt nothing and forgotten nothing.

For some years now my colleagues in CRESC at Manchester have been exploring the sources of  these crises.   Our conclusion  is that none of the standard explanations make full sense of what was going on and,  as the Coop fiasco shows,  is still going on. These standard explanations, oddly, unite establishment policy makers, radical critics and academic observers.  They come in three forms.  First, crisis as accident, a view inspired by Perrow’s classic study of ‘normal accidents’.  Second, crisis as conspiracy: a view now common on the left which treats the political parties as the catspaws of the financial elite.  Third, crisis as calculative failure: a view particularly common among reformist regulators who view the root of  all problems in the failures of the risk estimation models used at the height of the manic banking boom.  All three point in the direction of  technocratic solutions to the problems of banking regulation.  But what the Coop fiasco hammers home is that technocratic solutions have limited effect: we are now nearly five years into reformed  technocracy  and things are still going badly wrong. Our argument – and the reason we speak of the crisis as an ‘elite debacle’ – is that the crisis has, and continues to have, deeper roots in the mind world of elites, financial, regulatory and political.  

And that mind world is shaped by influences far removed from the rationalities of the textbooks of financial economics or the deliberations of technocrats.  It is at heart driven by forces over which actors have little control and little understanding.  The most obvious example of that is the financial system itself  which, far from being the result of  financial innovation produced by financial engineering is essentially the product of bricolage, in the sense used by Levi-Strauss: structures and practices are not designed but improvised  without any central guiding rationality. The result can be seen in the system which produced the crash and which still retains its essential features: a system marked by huge volume in trading, by inordinate complexity, by opacity in modes of trading and by dangerously high levels of interconnectedness.

This systemic irrationality is compounded by an irrational culture of  government decision making in Britain, a culture which has produced hubristic styles of leadership.  We mean ‘hubris’ here in its exact core sense:  excessive self confidence in one’s own judgement arising from a lack of contact with reality.  In delegating control of economic policy decisions such as interest rate setting, financial regulation and trade policy to newly empowered technocratic elites, politicians have freed themselves from everyday mundane reality, to concentrate on big picture ‘strategy’ – a word which trips effortlessly off their tongues.  What all this meant in practice in the years leading up to the great crisis was that, in plain English, political leaders in the Treasury did not have the foggiest idea of what was going on.  Hence the shock when the whole thing ended in tears after 2007.  And the case of the Coop shows that hubris and lack of reality still shape how political elites approach financial regulation: how else to explain the insistent pressure from Treasury Ministers to the Coop to expand, seemingly oblivious of its near bankrupt condition?

What is to be done?  Two things, both of which briefly surfaced in the crisis, and both of which have receded.  First, the irrationalities of  the financial system – complexity, opacity, magnitude – need attacking – an attack that was briefly contemplated in the aftermath of the crisis in the calls by figures like Andrew Haldane for a simpler financial system.  Those calls have now greatly diminished in volume and influence, especially under the new Mark Carney at the Bank of England.  Second, democratically elected politicians need to recognise their responsibilities.  It won’t do to hand over the responsibility for decision to technocrats and simply deliver big picture speeches about strategy.  But to get to that latter change we will probably need a different kind of politician.

Note: The blog draws on the published work of  the research team at CRESC, the ESRC Centre for Research on Socio-Cultural Change at the University of Manchester.  The two main publications drawn on here are Ewald Engelen, Ismail Ertürk, Julie Froud, Sukhdev Johal, Adam Leaver, Michael Moran
and Karel Williams, ‘Misrule of experts? The financial crisis as elite
debacle’ Economy and Society, 2012, 41:3, 360-82; and Ewald Engelen, et al, After the Great Complacence: financial crisis and the politics of reform. Oxford: Oxford University Press 2011.

Pooter