Doing What’s Easy: The Unbalanced And Unstable 2013 Recovery

“We cannot go on with the old model of an economy built on debt. An irresponsible public spending boom, an overblown banking sector and unsustainable consumer borrowing on the back of a housing bubble were the features of an age of irresponsibility that left Britain so exposed to this economic crisis. They cannot be the sources of sustainable growth for the future…We will build a more balanced economy which does not depend so heavily on the success of financial services, and where all parts of the country share in the gains…In the coming months we want to unite the country behind this new British economic model” George Osborne (2010) ‘A New Economic Model: Eight Benchmarks for Britain’, p.1.

Back in February 2010 the Chancellor wrote the above as a preface to a document which outlined the Conservative vision of a new economic model for Britain. The theme of rebalancing featured prominently in the eight benchmarks outlined in the document, which were to provide the gauge against which the performance of a Conservative government might be judged[1]. But with our economy apparently on the mend, we seem much further from the kind of sustainable model described in Osborne’s 2010 vision. We have instead done what’s easy and embarked on a strategy of reflating the housing bubble, predominantly in London, creating all kinds of uncertainties going forward.  

The basic post-crisis story is one of a two speed economy. This can be seen in the regional breakdown of the UK’s GVA growth (GVA being the standard ONS measure of output). The two charts below show that in the pre-crisis period between 1997-2006, London and the SE accounted for 37.3% of all GVA growth. Post crisis, this figure rises to 47.7%. If we were to strip out inflation, the picture is even more bleak with many regions still below their pre-crisis peak, illustrating just how far London has pulled away from the rest of the UK economy since the crisis. I am fairly confident the 2012-2013 picture will, if anything, show London taking an even greater percentage of national GVA growth.

Figure 1

The regional GVA figures only run up to year end 2011. But it is possible to get a sense of the form and extent of the current recovery using output GVA by sector. Figure 2 below shows that by end of year 2012 only three sectors had recovered their pre-crisis output performance: i) Agriculture, Forestry & Fishing (which represents a negligible part of the UK economy in monetary terms and broadly reflects rising commodity prices) ii) Business Services & Finance and iii) Government & Other Services. And even here growth was concentrated in a few narrow areas: motor vehicle repairs, admin and support services and real estate (mainly in London, but more on that later). Meanwhile health and education spending kept government services on the up. However since 2013 there has been broader sectoral growth (figure 3), particularly in professional, admin and support services and also in the wholesale and retail trade. Some growth is to be expected as concerns about the Eurozone crisis recede, as pent up demand relaxes and business confidence improves. But the precise form of the recovery and its sustainability are shaped by government programmes. So are we seeing the kind of economy that Osborne envisaged?

Figure 2

Figure 3

The answer to that really depends on the way the economy moves. Growth in one market or region can unexpectedly transmit confidence, investment and job growth to other parts of the economy in ways that are difficult to predict. But I am not too confident about this scenario and the immediate signs do not augur well.

The particular form of the recovery in the UK has been shaped by three central interventions: Quantitative Easing, Funding For Lending and Help To Buy. First, QE which was supposed to (among other things) lead to more lending to the productive economy, fostering a ‘march of the makers’.  This was supported by Funding for Lending, which to date has pumped a total of £17.6bn into banks and building societies. Neither has met their perceived aims. Net lending to business has in fact been negative on an annual basis since QE began in March 2009 with little deviation from that trend as Funding for Lending was rolled out in July 2012 (figure 4). Corporates have instead paid back bank debt and bought back shares by issuing bonds to massage EPS figures and trigger bonuses for the board; meanwhile investment is still pretty insipid – hovering at around 20% below the August 2007 figure. Unsecured lending to individuals however has increased: credit card loans were up 4.5% on an annualised basis in August 2013, while other unsecured loans were up 4%. Secured lending has also been rising steadily since mid-2012, perhaps showing some benefits of Funding for Lending; but there is evidence to suggest that these mortgage-related loans have been regionally concentrated in the London area, pushing up prices above the already eye-watering pre-crisis highs – which takes us to Help To Buy.

Figure 4

Source: Bank Of England ‘Trends In Lending’ October 2013, p.4

Help To Buy equity loans and mortgage guarantees have effectively pump-primed housing demand (with negligible effects on supply). Via the equity loan, government lends homebuyers up to 20% of the purchase price of a new build house up to £600,000. The more controversial mortgage guarantee provides banks with free insurance on up to 15% of the value of any mortgage loans issued. All of this is geared towards top-down growth - encouraging the upper middle classes to dis-save in the hope that ‘dwellings investment’ (private new builds plus extensions on private houses) would restore confidence and kick start consumption spillovers. This is also why the government has also been so keen to relax planning regulation on building extensions.

The benefits of all three interventions have disproportionately accrued to London. Figure 5 shows an index of average regional house prices rebased to August 2007, illustrating just how far London has pulled away from the rest of the UK housing market: prices in the capital are now 14% above where they were back then. This has not just been driven by hot money from rich, foreign investors in the prime market where 60% are cash buyers. Despite the hullabaloo about prices in Kensington, the prime market in London is only around 7% of the capital’s total; in fact London is the region with the lowest percentage of cash buyers in the country by a distance (24% vs 39% in the SW). This means a greater proportion of buyers require borrowing in London relative to elsewhere. And although transaction volumes appear to rise and fall in lock step across the country, London’s volumes are now the highest relatively at around 62% of the August 2007 peak compared to other regions which run from the low 40%s to high 50%s from peak (figure 6). So London has a higher number of transactions relative to peak with a smaller percentage of cash buyers.

Figure 5

Figure 6

The house prices and the growing volume of transactions in London have been driven by an expansion of secured lending, under-written in various ways by government. This has been reinforced by an expansion of unsecured credit, also underwritten by recent interventions. These, in turn, have kicked multipliers into the London economy. But can this last?

It is difficult to escape the image of London breaking free from its moorings in the national economy, just as the value of its real estate becomes detached from any fundamentals. If London real estate is 14% higher than peak on just over 60% of volumes, then London houses look increasingly like a kind of (state-subsidised) collectors market bubble whereby it is the imagined attributes of the asset within a relatively small community of buyers that drives prices beyond underlying fundamentals. The fundamentals in question are wages. As figure 7 shows, median house prices are now virtually unsustainable at around 9 times FTE earnings in London; with the Midlands, North and Wales hovering around a more modest 5.5X to 6.5X. We should also not forget that intra-regional inequality is just as important as inter-regional inequality. London has rafts of low and modestly paid workers – and at the lowest paid end, those conditions are worsening (figure 8). These income constraints represent a kind of risk threshold – prices can continue to rise relative to income, but they can only do so at greater risk of collapse. Only this time when the bubble goes pop, the government and the Help To Buy generation who have invested some equity will be the ones who take the downside.

Figure 7

Figure 8

Source: Annual Survey of Hours and Earnings (ASHE), cross-sectional dataset. http://www.ons.gov.uk/ons/about-ons/business-transparency/freedom-of-information/what-can-i-request/published-ad-hoc-data/labour/october-2013/low-pay-in-london--1997-2012.xls

So here are some troubling questions:

1. London prices are 14% above the pre-crisis August 2007 level on just over 60% of the volumes. Can those low volumes support high prices over the longer term? Or alternatively can volumes increase without prices falling, given the income constraint? Either way, the sustainability of the price boom (and the multipliers that accrue during an uplift) look shaky.

2. If prices were to waver, how would government respond, given it has taken on a £130bn contingent liability – equivalent to 8% of GDP - through the mortgage guarantee scheme? Should it extend its equity involvement to 25% or 30% to make mortgage payments more manageable for households and bring in a greater volume of buyers? Should it extend larger guarantees to the banks to lubricate the wheels of debt issuance and ensure prices move upwards? What looked like an initial injection to spark the recovery, very quickly becomes mission creep.

3. Inflation is an inconceivable threat in the short to medium term, but what about in 5 to 7 years time? Government, as an equity holder in the UK’s housing stock and guarantor of banks’ mortgage loans, now has a vested financial interest in stable/rising house prices. Given that high house price to income ratios are only sustainable in a low mortgage interest rate environment, how might government respond if the Bank of England concludes that interest rate rises are necessary at some point in the future? Or what happens if ruptures in the interbank/money markets reappear and cause mortgage rates to rise? Even modest rate rises could lead to mortgage defaults, collapsing confidence, fire sales and falling prices when households are geared to the max in a low rate environment. By taking a directional bet on property, government is invested in a ‘close to zero’ interest rate regime, irrespective of what uncertainties lie ahead. This stores up all kinds of potential economic and political tensions going forward.

Through Help to Buy and other interventions, government has gone long Britain. That may sound like a good thing, a patriotic thing even, but it is not. This is an all-in move by the Chancellor, which is a problem. Like any complex system, an economy needs buffers and release valves to prevent overheating or interference in one area that might cause total seizure. His interventions have done the opposite. What if Eurozone problems resurface? What if another bank is hit by unexpected losses, and LIBOR rates rise? This growth model is not built with what ifs in mind; there are few system redundancies to deal with the unexpected. We are long house price growth, long low interest rates, long consumer appetite for debt, long the Eurozone, long bank stability, long consumers’ ability to transcend their financial constraints and keep buying more expensive houses.

Finally, what of Osborne’s noble ambitions set out at the top of this post? When push came to shove he bottled it. He did what was easy: state intervention to help rebuild fractured supply chains and invest in growth requires skill, guile, political and economic nous and courage to fend off the vultures. The de facto part-nationalisation of the private housing stock (and that’s what Help To Buy is, in effect) to prop up an over-heated property market and save the banks from further write-downs is the easiest thing you can do as a Chancellor in such times, with an election looming. This recovery looks much less like the new model promised by Osborne, and much more like an unstable version of the old one.

Stanley

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[1] Although the original link to those eight benchmarks has disappeared from the Conservative website, it is possible to access the whole report via the search function.

The English Premier League: Unintended Consequences

The world often follows the law of unintended consequences. Institutions are formed, laws are passed and processes implemented to remedy some pressing problem, only to find some new, wretched misfortune come crawling from its structures. We can see this in finance, where the well-intentioned risk-weighted capital adequacy ratios of Basel II encouraged banks to create ever more elaborate synthetic securitisations which ended in global financial catastrophe. We can even see it in my profession – academia – where Thatcher’s Research Assessment Exercise (RAE) (now the Research Excellence Framework ‘REF’), was expected to rectify a perceived lack of quality and productivity in the research output of the university sector. The result – arguably – is a homogenisation of output and soar-away wages at the top as academics willing to play a mercenary REF game pit employers off against each other, with uncertain outcomes for the collegiality and cost control that have traditionally held those institutions together. Paraphrasing Chris Dillow, Thatcher’s vision was of a diligent and creative University sector exercising moral restraint: she wanted universities staffed with people like her father. She got universities with people acting like her son.

But the topic of this blog is not finance or academia, it is football. And football represents another good example of unintended consequences. In 1991 when the big 5 clubs (then - Manchester United, Liverpool, Arsenal, Tottenham Hotspur and Everton) were approached by Graham Kelly of the Football Association (FA) to form a breakaway league, it was done on the promise that fewer games would lead to higher quality football, which in turn would encourage new money from TV and sponsors. It was anticipated that this would stabilise the financial position of clubs within the league, allowing them to invest in new facilities and improve the experience of matchday fans (Guardian 8^th April 1991; The Times 9^th April 1991). Support for the new league also took place against the backdrop of the Taylor Report which required clubs to convert to all seater stadiums. It also reflected the FA’s paranoia about the parlous state of the English national team, and the prospective loss of English talent to the Italian league (Independent 9^th April 1991). The rest is history. The deal was done very quickly with the FA and the elite clubs effectively winning a power struggle with the Football League. Murdoch spied the opportunity to cement his new subscription television channel – and the Premier League was born.

It is interesting now to look back on those promises and see how much has changed. Certainly the prophesied income streams did materialise. Television and commercial sources of income as a percentage of total income have increased. Similarly average attendances did grow, from around 21,000 in 1992 to a peak of around 36,000 by 2007/8 – although some of that growth is down to an averaging effect in a smaller league. But contrary to expectations the new income did not improve the economic stability of those clubs. In fact, arguably the opposite has happened. If we were to track the total operating loss of the top two leagues after player trading and interest, but before tax this is a sector whose fundamental operating characteristics have degenerated over time.  According to Deloitte, by 2010/11 the aggregate pre-tax loss of the teams playing in the Premier and Championship combined was £569m. Similarly, although facilities for fans have undoubtedly improved, that has come at the price of escalating matchday prices, squeezing out lower-waged core, local support.

Source: Deloitte (2012) Annual Review of Football Finance

So how did this come to pass? To answer that question we need to think about the financial characteristics of the game and the governance mechanisms within which the industry is embedded.

One of the central puzzles of the football industry is why so many people seem willing to buy into an industry with secular profitability problems? Of course there are squillionaires like Roman Abramovich and Sheikh Mansour Bin Zayed Al Nahyan for whom the club is a status symbol and whose multi-million pound investments are the equivalent of the annual depreciation on our motor cars. But there are many other owners for whom the relatively predictable cashflow from the game has some appeal, even though margins are generally low or negative. Cashflow is important because it gives prospective owners the option to purchase a club with debt, giving them control with reduced personal financial commitment and exposure. Measuring the size of those debts is tricky because it often sits in one or more of the holding companies used to buy out the club, which can descend onto the operating entity to disastrous effect. The Guardian puts the net debt figure for the Premier League at £2,408.5m on losses of £205m; where interest payments account for £100m of that £205m loss. Deloitte estimates that net debt in the Championship was £720m on a loss before tax of £189m. There is some evidence that in the last 2 years debt has fallen in some cases, but the general characteristics of a levered, negative margin business remains.

But not all of the losses are due to interest payments, so are there other reasons why football clubs are so attractive to investors? When only 7 of the 20 Premier League clubs and 10 of the 24 Championship clubs are wholly owned by UK nationals, that’s an important question. Positively, they offer cachet to the buyer on an international stage and may provide an option on jackpot returns in the future. That is a very real option because each successive television deal offers lucrative revenue growth that will be capitalised in the future value of the club. Similarly a championship club reflects a solid build and sell opportunity, particularly if they can get promoted and established in the Premier League. That may partly explain why losses are tolerated in the short term. But there are other less palatable attractions. The cashflows are eminently clippable and the assets eminently strippable, so that even if the club posts losses, individuals at the apex of the club can skim cash through emoluments and other payments, dividends, commissions for interested parties, iffy sale and leaseback deals, interest payments to financing holding companies and a myriad of other mechanisms designed to get more juice out of the lemon. This is possible because the industry is notoriously opaque and riddled with complex corporate structures that inevitably reach out into the tax havens of the Caymans, Guernsey and elsewhere. This leaves the door open for all kinds of unseemly behaviour.

This last point is a central theme of CRESC's recent research: the relation between elites and the firms in which they carry out their business. In football those elites are not just owners, but also players, managers and their representatives who all place claims upon the club. The general argument that I and my colleagues make is that the growing internationalisation of revenue flows has created value skimming opportunities for well placed individuals. In football, the absence of any control mechanism – either on the corporate governance side through fan ownership or on the regulatory side through a wage cap - means that those well-placed individuals weaken the club’s financial position. Paradoxically, however, the game has become more reliant on those individuals: the network connections, particularly between clubs, managers and agents, now critically determine the access to talent which may improve on-pitch success. Those interpersonal network connections are thus both a source of revenue creation or capture and a means of securing the success demanded by fans; but they are also a source of fragility because those same networked individuals come at a price - they are, in other words, extractive too.

The outcomes of all this are very uncertain. It raises all kinds of confusion about alliances and allegiances from the fans’ perspective: who to identify with, and who or what is the problem? There is a noticeable shift in the discourse from elements of the support base, from a concern with the club as a social institution, to an increasing identification with the corporate concerns of the elites within the club. But the traffic has not all been one way. Equally there is growing resistance to the commercial representations and activities of the club – perhaps most dramatically illustrated in the takeovers of Manchester United and Liverpool, where the owners’ use of the term ‘franchise’ became an emblem against which many supporters groups mobilised. Nevertheless we see a second fragility emerging beyond the financial characteristics described above: there is an equal withering of the club as a social institution. And this fragility is in part a product of the growing influence of elite networks around the game.

New money should have stabilised clubs, but it has not. Clubs as both cultural entities and economic institutions have become more fragile and wrought with tensions as new elite networks become central to the capture and extraction of revenues in the sector. The FA’s approach to ownership is in keeping with a form of capitalism peculiar to the British, where everything is for sale provided the purchase price is right. But the game in its current form is not sustainable. Clubs as financial entities cannot continue without regular loans or other cash injections. There needs to be a countervailing force which keeps value skimming and extraction by these networks in check. Greater fan representation on the board might just provide the long-view needed to do just that.

Mr Pro-Celebrity 5-Aside

NB: A CRESC Workshop on these and other themes will take place on Friday 17th May 2013, details below:

CRESC Workshop: Football, Fans and Finance

Friday 17th May, 10am – 4pm

University of Manchester

Kanaris Lecture Theatre, Manchester Museum, Oxford Road, Manchester

Workshop Panel:

Andy Burnham (MP), Andy Green (Andersred blog), Jim White (Telegraph)

Other Workshop Presenters: 

Adam Brown (MMU and FC United of Manchester Board member), 

Christine Cooper (University of Strathclyde), 

John Hughson (UCLAN)

Pete Millward (Liverpool John Moores).

Cost and registration details: £20 (includes refreshments and lunch); £10 concessions.

Limited spaces: to book your place please contact: heather.whitaker@manchester.ac.uk

Electrification Will Not Prevent Future Crises

'' When the RBS failed, my predecessor Alistair Darling felt he had no option but to bail the entire thing out...Not just RBS on the high street, but the trading positions in Asia, the mortgage books in sub-prime America, the property punts in Dubai...I want to make sure that the next time a chancellor faces that decision, they have a choice. To keep the bank branches going, the cash machines operating, while letting the investment arm fail.'' George Osborne, Feb 4^th 2013.

George Osborne chose JP Morgan’s international processing centre to announce his proposal to ‘electrify’ the ringfence between retail and investment arms of UK banks, giving government a reserve power to split a bank should the fence be breached. Amidst the brouhaha that followed, it is perhaps worth asking whether separation resolves many of the problems which led to the crisis anyway.

Osborne’s announcement itself was more political pantomime than theatre, overwrought with cheap symbolism and reliant upon audience participation. The backdrop bore the JP Morgan logo portraying Osborne as the brave hero, the very epitome of a man fearless of audience and setting, prepared to deliver his devastating message mano-a-mano with the bankers in the heart of their territory. The speech drew predictable ‘boos’ from the yahoos in the stage-boxes as the BBA trawled out the usual line that this would mean less lending to businesses and a diminished role for London as a financial centre; points made with such monotony that one has to wonder whether Anthony Browne has a draw string on his back.

The shock and disbelief of the industry are of course staged, but essential to the overall act. The banks need to look like they’re feeling some pain so that the British public avert their vindictive gaze, satisfied that revenge has been exacted. Similarly Osborne needs a setting which projects his own strength but doesn’t risk public embarrassment, which is why this speech took place in the polite back office lagoon of Bournemouth, not Canary Wharf among sharks who are likely to bite; all vital as the economy teeters on the brink of austerity-fuelled decline. But behind this performance, the pre and post Vickers process has been lobbied heavily by the banking industry. Key industry actors would have been aware of Osborne’s intentions. Some may even have had a role in shaping the parameters and smoothing out the rough edges (note Osborne’s speech only says government will have ‘the power’ to separate, not that it ‘will’ separate – ominous if we remember how large corporations may use their political power and influence to avoid being split). When the amendments were announced, not an eyebrow was raised on the markets: the share price of Barclays and RBS dropped only modestly and in line with the index, suggesting that much of this was anticipated anyway.

But this all raises a bigger question. Let’s suppose we had Glass Steagall not Vickers’ fence, would we be safe from another crash? My opinion is probably not.

The causes of the crisis were/are manifold: the scale of banking liabilities relative to national GDPs; the interconnectedness of banking institutions that accompany that scaling up; the complexity of many innovations which connect these institutions and thus produce system fragility; and the opacity of the accounting information which produces uncertainty at times of stress. Central to all of these problems is the over-supply of credit. The problems of the 2000s can all to a greater or lesser extent be thought of as what happens when banks discover that they can a) lend money against a secured asset without first having to take deposits and b) discover that they can readily produce or access assets against which they can borrow. That is a circuit; the cogs and wheels of the bubble machine.

Modern Monetary Theory (MMT) has something to say here. MMT implies that banks don’t gamble with existing deposits, rather they make loans (assets) first and in doing so create deposits (liabilities) as the sum lent is credited to the borrower’s current account (this is the double entry balance sheet accounting identity). Banks then finance those deposits (or liabilities) crucially after the loans have been issued (the cashflow accounting identity). During the boom years they were able to do this relatively simply through central bank reserves or the short term markets, securing their loan with their newly acquired asset. But as the crisis bit, asset quality (or perhaps more accurately the perception of asset quality) deteriorated: the AAA mortgage backed securities, the Southern European sovereign bonds, etc that had been accepted as collateral by private lenders, all of a sudden lost that particular property. The story of the crisis therefore is really a story about the shortage of good, rehypothecatable collateral and the inability of banks to finance their liabilities while their asset position deteriorates. This is why the ECB and other central banks are working so hard to reignite the interbank market by accepting more and more dross from bank balance sheets as collateral for loans in the absence of willing private counterparties, or swapping them for ‘good’ assets which are. Central banks have in no small way become ‘rehypothecators of last resort’.

From this perspective, it doesn’t really matter if investment and retail banking operations are separate. The national and global economy relies on its investment banks just as much as its retail banks. The modern economy needs institutions that finance larger businesses, arrange M&A activities, underwrite share issues and develop hedging products for multinationals. These functions will always need to be propped up by the State if the institutions that perform those functions begin to teeter. The fundamental problem therefore is not the presence or absence of a retail arm, but the scale of the liabilities and the interconnectedness of those investment banks as the speculative activities are bundled in with their more ‘functional’ activities.

The separation of wholesale and retail may have worked in the 1930s, but it is inadequate now. It matters little whether the investment banking arm of a universal bank buys mortgages off its in-house retail arm or the retail arm of another universal bank. The macro/systemic effects are the same when scale and interconnectedness come into play. Here at CRESC Towers we are reminded of Moliere’s quip that nearly all men die of their remedies and not of their illnesses. One can’t help feeling that Osborne’s pantomime toughness and unwillingness to tackle this primary problem of scale and interconnectedness at the wholesale level, may just provide the diversion that banks need to continue business as usual.

Stanley

If They're London's Revenues, They're London's Liabilities

“I would like somebody, anybody, to fight for me – the middle class of London and the South East.... As a standalone entity, the people of Berkshire, Buckinghamshire, Sussex, Hampshire, Kent, Oxfordshire, Surrey and London are 18th in the global GDP league, just ahead of Indonesia and just behind Turkey. If you took this region out of the UK economy, it would be called Ethiopia...The subsidy from London and the South East to the rest of the country is truly astonishing...This area needs its own party. It needs a leader who believes that the striving classes in the South are overtaxed and overburdened”. (Kelvin MacKenzie, Telegraph 2 December 2012).

"You can't revive the regions just through handouts from Whitehall…Revenues from the financial services sector were recycled round the rest of the country through the long arm of the state, creating the illusion of strong, national growth. Jobs were created but in an unbalanced way, over-relying on the public sector, funded by tax receipts from the City of London. And we've seen what happens when the conveyor belt breaks, as it did spectacularly in 2008. Those tax receipts fall, the money stops flowing and the whole country feels the consequences as the public sector contracts and jobs are lost. This nation is made up of 100,000 square miles. It cannot rely so heavily on one." (Nick Clegg, October 2012)

A financial crisis will always lead to greater competition over resources, and so the steady flow of news articles about the ‘unfair’ subsidies received by the regions is of no great surprise. Neither is the response from the condottieres of the Thatcherite Right like MacKenzie who have seized upon such reports to invoke a new moral language which asserts regional proprietorial rights over revenue streams and laments the distorted incentives which encourage an indolent North to live off the efforts of hard-working Londoners; all highly emotive in these austere times. In Nick Clegg these defenders of the brave South have found a Parliamentarian from the North willing to carry - and embellish - this story. Similar tales are told across Tory and Labour front benches; and within the metropolis, certain progressives and conservatives are united in their belief that the North has had it a bit too easy for far too long.

But as Londoners and their informal representatives look on jealously as the bank notes disappear over the Watford horizon, it is perhaps worth revisiting this argument. And it is a complex issue that deserves balance and open-mindedness to understand the diversity of flows in a national economy.

It is a story that we have touched on in the past. In a previous paper titled Rebalancing The Economy we emphasised the importance of the state and para-state as a source of Gross Value Added (GVA) and employment growth in the regions. We also noted the growing GVA per capita relative to the national average in London and to a lesser extent the SE, and the growing presence of financial services GVA in London relative to the national average. So, in a very simplistic way using static data there is a degree of truth in the claim that private sector surpluses generated in London and the South East were recycled as public sector jobs in the regions. But this is to put arithmetic to a very basic misuse.

This story ignores the general problems of a national business model that relies less on the manufacture of things and more on the manufacture of credit. It is a startling fact that the real value of housing equity withdrawal under Thatcher and Blair was marginally larger than the real value of GDP growth, suggesting that for our national economy to grow we require free flowing credit pushing against asset prices which can quickly and easily be cashed out. It is within that context that we should perhaps understand the current attempts by the Bank of England, the State and its various exigencies to prop up house prices by keeping interest rates low, and by encouraging lenders to avoid repossessing properties where households are in arrears on their mortgage. This nervousness about feedback effects and the fragility of the finance sector shows what a truly sorry state of affairs we are currently in. And it is a state of affairs that can be directly traced to the attack on industry by the Thatcher government which has left us with a kind of modern day credit-based equivalent of Eisenhower’s military-industrial complex of the 1960s and 70s.

Perhaps more importantly this Londo-centric story also ignores the vast public costs of underwriting the capital’s financial services sector: by our calculations, the Treasury received taxes of £203 billion over five years up to 2006/7, which were substantially less than the cost of the UK bank bailouts, estimated at between £289 billion to £1,183 billion by the IMF. So Clegg is fundamentally wrong on this issue: the banks are a net recipient of State funds which the whole country must pay for, even though the private gains are largely realised in London and the SE. From this perspective, we, in the North, have also seen our bank notes disappear over the Watford gap to keep well-heeled investment bankers in a manner to which they are accustomed.

This might sound like cheap point scoring, but beneath it lie subtler questions about the direction of the financial subsidies in a national economy. Is a reliance on State support the preserve of the North, as Clegg and MacKenzie suppose?

It is possible to deconstruct London’s success differently. Global cities like London do attract capital, but they do so because they are a kind of conversion machine, taking national and international assets, converting them into revenue streams from which well placed individuals skim high pay. London attracts capital because it is also extractive in other words. This can be seen from investment banking to private equity to infrastructure PFIs. This process of extraction requires an active state, through bailouts and subventions in the banking system to the underwriting of risks in infrastructure PPPs and PFIs. This implies the centrality of the state to a proportion of the UKs private sector.

PPPs and PFIs are a good example of where ‘extraction’ has distinct regional effects. The decomposition of activities around a contracted-out infrastructure project leads to a fragmentation of corporations around specialised functions, so that one company may provide the finance, another may build the school or hospital, another may manage the asset etc etc. In theory some of these functions need not be located on the site of the project. And certainly the revenue streams do not all circulate regionally: the finance company probably has its operating office in London, as might the asset management office. Even the operations might be co-ordinated from London using local contractors on site. Overseas companies that invest in PPPs/PFIs are likely to have an office in London, and those senior workers are likely to be extremely well paid.

Before PPPs and PFIs, projects that were State funded had revenue streams that would congeal in the regions where those projects were based, kicking in multipliers that would further benefit the local economy. The fragmentation of activities has led to a concentration of certain functions like financing and asset management in London. This has diminished capacity in the regions through the withering of broad competences, the fragmenting of supply and project chains, and skills drift as talent is forced to relocate down South to find a job. State-sponsored investment projects across the country have benefited private sector growth in London and the South East.

But infrastructure projects are not just about where the revenues go, but what liabilities are taken on to generate those revenues; and crucially who assumes responsibility for those liabilities when things go wrong. Many PPP/PFI schemes are highly levered: before the crisis projects were financed on around a 90/10 split debt to equity, though this has now levelled down to around 70/30. Even so, leverage produces interest payments that require servicing and a manifest risk of default. So the flipside to the revenue streams clipped by metropolitan elites is a tower of hidden contingent liabilities that may be passed onto the State, as when NHS Trusts cannot repay their PFI loans. Similarly on the operations side, contracts which allow companies to exit their obligations (designed to attract initial bidders) may leave the State with unexpected costs. This is what First Group did when it walked away from the backloaded premium payments on its First Great Western franchise, costing the taxpayer an estimated £800m in lost receipts. On the contracting side, unwieldy contracts can produce inefficiencies and exorbitant penalty clauses which are costly to renegotiate. And this is before we discuss the many contracts that overshoot their original estimates. All of these interventions should be thought of as State subsidies; received mainly by private subsidiaries operating in the capital, and paid for by taxpayers the length and breadth of the country.

This quiet cross-subsidy from North and West to South East has been running un-noticed for a long period of time. Its unanticipated result is a kind of regional moral hazard: the metropolitanisation of gains, and the nationalisation of losses.

So returning to the question of fairness and national cross subsidies: it strikes me that Kelvin MacKenzie is the kind of odious character who, had he been alive in Biblical times, would have written a sneering editorial about the ‘beggar’s charter’ created by the actions of do-gooder Samaritans. He will therefore understand this dilemma about regional moral hazard because London receives a subsidy that is not paid for by Londoners. If we are to resort to the kind of petty proprietorial politics that MacKezie and Clegg espouse, then let’s get one thing straight: if they’re London’s revenue streams, they’re London’s liabilities too. So next time, when the banks blow up or another PFI deal hits the wall, the liability costs should fall on the shoulders of Londoners and the South East alone. Let those metropolitan taxpayers bail out the banks. Which political party or mayoral candidate could fail to get elected on that platform?

Stanley