BarCamp

These "UnConferences" originated in the techie world, and continue to be oriented around the application of technology to various subjects.

I am attending

BarCampBank London

which, as the name suggests, is one of a series of BarCamps on the subject of Banks, and is in fact the first such in London - this Saturday, 5th July.

I aim to contribute my thoughts with a working title of "Beyond Credit", and by way of background, have just posted the following explanatory page on the BarCampBank Wiki.

There are essentially two financing requirements which credit unions and banks currently address.

(a) Credit - short term and unsecured credit - which is essentially "time to pay". This is often known as "Working Capital", and all businesses need the ability to finance the credit they typically extend to customers.

(b) "Investment" - Medium and long term credit - typically secured by a "charge" or a mortgage - which is used to finance productive assets, such as property and machinery. This is often known as Fixed Capital.

I have been working in Scotland with a Scottish charity/social enterprise - the Nordic Enterprise Trust (part financed by the Norwegian government)- to develop partnership based mechanisms to allow "micro" enterprises to obtain both types of financing, which they are finding increasingly difficult, if not impossible, to obtain. Of course, the problem of restricted access to financing is not - post "CreditCrunch" - limited to "micro" businesses - it's just more acute for them.

These partnership mechanisms are based upon using legal forms like the US LLC and the UK LLP (very different from US LLP's) as "frameworks" for risk and revenue sharing as follows:

(a) "Guarantee Societies" - risk sharing "communities of interest" with a "Common bond" (as with a Credit Union) which offer mutual guarantees of bilateral "Trade" credit extended from seller to buyer.

The guarantee is backed by provisions made into a "Default Fund" in collective ownership, and the system (ie Guarantee Limits, accounting system, defaults) is managed by a service provider aka a Bank or Credit Union.

So no "interest" is charged for credit per se, but an amount is charged for system costs and shared default costs. The result is "Not for Profit" (but also "Not for Loss" !) and dis-intermediated banking. The banks are happy, since they no longer have to risk their capital by creating credit based upon it, and may become pure service providers instead.

(b) "Capital Partnerships" - allow any enterprise (Public or Private; charitable, social or commercial in aims; whatever legal structure) to enter into a partnership within an LLC or LLP framework and simply to share gross revenues - or even production eg kilowatt hours - with investors.

Using Capital Partnerships, new asset classes become possible:

(i) non-redeemable (but tradable) proportional % age shares ("n'ths") in production or revenues;

(ii) Units redeemable against a specific amount of production (and carrying no income) eg the right to 10 Kilowatt Hours, or the right to use an acre of land for a year.

So a wind turbine may be funded simply by selling Redeemable Units to the value of maybe 30 to 40% (depending on location) of its production to investors, who (as with gold) would receive no income but would have the chance of a profit if energy prices increase, but also have the option to actually use the energy. (gold not being much use to heat your house).

These mechanisms make redundant both conventional shares (in - say - a Corporation) and also secured loans, by superseding them with two simple but radical new types of financial asset.

The role of banks and credit unions in such investment financing is once again "dis-intermediated" since they need not risk capital by creating credit based upon it, but may instead act as:

    * system operators
    * advisers/appraisers
    * introducers, bringing together investors with investment; and
    * "market-makers" providing liquidity.

In summary,I am saying that these "emergent" (LLP's are in pretty pervasive use in the UK now) mechanisms will allow us to achieve banking without banks or credit unions as credit middlemen, and with institutions formerly known as banks and credit unions as service providers.

The enabling tools are the partnership-based protocols - legal XML if you will - that allow us to link disparate individuals and enterprises together across borders in legal and financial terms.

The outcome could be a networked "Clearing Union" upon which fungible Units of Value change hands facilitated by credit = "time to pay" which is itself supported by a mutual guarantee and backed by a pool of assets in common ownership.

Chris Cook

2 July 2008

Michel Bauwens - guru of the evolving "Peer to Peer" trend, and founder of the P2P Foundation - has incorporated this text, and linked to ET here

Networked Clearing Union

Having been in London on Friday on "business" I dropped in on the Labour Representation Committee [pdf!]event Beyond the Market Economy [pdf!]. The Labour Party, of which I used to be a member, and my father before me, is in a turmoil.

The LRC is essentially a forum put together by the left wing MP John McDonnell, and the event was attended by both the "Organised" Left - ie the Unions; the plethora of left wing splinter groups (immortalised in the Monty Python's "Life of Brian") like the Socialist Workers' Party - and the "Disorganised Left" ie a host of disillusioned former Labourites like me.

The underlying theme was that Market Capitalism has failed, but that State Capitalism is not the answer either. The event was a hot bed of ideas and there were three out of the four Sub Plenaries which I wished to attend: anyone on ET familiar with my outpourings will see why.

I settled on the sub plenary covering "Ending Corporate Power" on which, perhaps more anon.

This Diary, however, comes from a throw away remark made by that magnificent old war horse Tony Benn at the end of his remarks in the context of a coming tidal wave of repossessions, and the need for campaigning ideas, new "narrative" etc.

Diary rescue by Migeru

It's not called the "Brent Complex" for nothing! I often assume more familiarity than exists.

I am conscious that my own knowledge has not kept up with recent developments in the market and have been busy researching and trying to get my head around the current structure.

Early Days
By way of a history, the "Brent 15 Day" contract was a set of contract terms developed by Shell in the late 70's / early 80's which- unusually - allowed the resale of "Cargo -size" parcels of crude oil produced by their North Sea Brent crude oil field.

A market in these forward contracts rapidly developed, assisted by rampant tax "spinning" ie sale and repurchase of forward contracts successfully (albeit only temporarily!) aimed at exploiting tax loopholes.

This Shell 15 Day Brent contract essentially specifies a contract month within which - after a certain "expiry date" in the month before delivery - buyers may give 15 Days' notice of their intention to "lift" crude oil within a nominated 3 day delivery "window". Once buyers have specified this "window" pursuant to a Brent contract, then the contract becomes what is known as "Dated" and the cargo becomes "Wet".

The purchase and sale of Dated Brent cargoes is as close as one gets to buying "Spot" Brent crude oil on a market.

Enter IPE
In the late 1980's, the IPE tried twice to introduce standardised physically deliverable Brent Crude Oil futures contracts, and failed because of incompatibilities between the 1000 barrel contract size and the delivery size of 500,000 barrels, combined with excessive "operational tolerances" in deliveries (ie  the seller could deliver 500,000 barrels plus or minus a 5% age delivery tolerance, recently reduced to 1%)

So the IPE introduced in the end a futures contract which was "cash settled" on the expiry date some six weeks before the relevant contract month. It was settled against an "Index" of the prices reported by market observers like Platts (in particular), Argus and others.

Platts are hugely important in the oil market and it is their "assessment" of the Dated Brent price against which 65% of global crude oil is priced. Platts have always had an interest in solving problems in the Brent market as they developed, and try fastidiously to be perceived as "neutral".

Through the late 1990's the decline in Brent Crude Oil production was already causing problems, because market players would often try and "squeeze" the market by buying up as many forward cargoes as they could, and then "squeezing" financial players/traders, who had speculatively sold 15 Day contracts in respect of oil they did not have.

Also during this period- which was my time at IPE - new trading tools developed to enable market players to "hedge" the price risk they had between the expiry of the IPE contract and the actual "Dated" delivery.

The major bust up I was involved in a few years after I left IPE related to manipulation of the IPE contract daily settlement price. This was "micro" (short term) manipulation, as distinct from major market medium term plays involving big trading positions, which I characterise as "macro" manipulation.

This "micro" manipulation created losses for the traders "on-exchange" which were more than offset by profits "off-exchange" on contracts or instruments that were priced against IPE contract settlement prices, ie a "sprat to catch a mackerel".

As you know, my allegations were rejected (albeit they were absolutely correct and well founded, and since confirmed) and I was professionally buried and discredited.

Developments Post 2001
Since then, the Brent field has continued its secular decline and not only have additional oil fields (Forties was introduced to the IPE contract spec during my time at IPE, and Oseberg since, to give rise to the "BFO" acronym) been brought in within the "Complex" but also the trading mechanism has developed in subtle but important ways.

This paper on BFO from Platts is excellent and pretty much definitive

Introducing BFO

also

BFO FAQ's

is a good description of the market structure as it has now evolved.

This

Clash of the Titans

was an interesting description of the struggle between BP and Shell in relation to the evolution of the contract. It is not clear to me exactly who, if either, actually "won".

Also an informative link in relation to the esoteric - but very important - "Contract for Difference" market which allows the price risk to be managed, and without which financial market players ("Wall Street Refiners") could not operate.

Brent CFD's

So we have seen some important developments in recent years to give rise to a BFO complex, and a plethora of trading in the ICEFutures cash settled "BFO contract" as it technically now is, and the re-jigged "BFO" market itself.

Brent/WTI
The physically deliverable WTI itself has become increasing irrelevant (as WTI itself - like Brent, declined) and during the last few years has essentially become an adjunct to Brent through a massive trading mechanism known as the Brent/WTI Arbitrage.

This article - ironically by Hess, in my experience one of the "usual suspects" on the market - is useful background on the situation some seven years ago

Brent/WTI Arbitrage 2001

and things have moved massively against NYMEX since then, as a large part of WTI trading migrated to ICEFutures in London, following the "London exemption" to CFTC speculative position limits (where I am reserving judgement).

This article last year is good

Clash of the Titans - Round Two

The BP/ Goldman complex
BP and Goldman are joined at the hip, both in governance terms - which is a matter of record (ie same Chairman, common Directors etc): and in economic terms both have made massive profits from energy trading - profits are how you reach the top in Goldman, and energy trading has always been Blankfein and Cohn's show.

Structurally BP have always been massively "short" of the BFO market, since they have always "hedged" their Forties and other production using the IPE/ICEFutures contracts and associated trading tools to do so.

Goldman,on the other hand has long had its massively successful GSCI and huge amounts of money have been invested in funds which are "invested" in Brent and WTI contracts and "rolled over" every month.

Goldman's trading arm J Aron has routinely "Date Raped" these positions as they roll over. See John Dizard, here.

Date rape

Goldman was also making routine use of the IPE settlement trading loophole I exposed, but that fact was buried.

But that IMHO is nothing to what has been going on between these two, in the last 10years.

Evolution of Manipulation - From Micro to Macro?
I believe that BP and Goldman's "matched" long/short Brent/BFO position has allowed them to act jointly as something of a fulcrum for manipulation. So that when one of them "bids up" the market - possibly losing money in doing so - the other will make matching profits, which it could -were it so minded - reimburse with "wash trades" (ie laundering) trades "off exchange".

Both parties would then benefit from the fact that this artificially induced volatility made them profits on their "off-exchange" dealings eg they could sell options at overpriced premiums because the volatility was artificially high. Also hedgers using OTC deals with one leg based on the IPE contracts would lose out because their hedging loss would be greater, or hedging profit less, than it should have been.

Both made lots of money in this way while the market was in oversupply and relatively stable.

In the early 2000's we saw the entry of hedge funds - speculative money - into the market, and BP/Goldman etc essentially lost control of short term market pricing (medium and long term pricing has always been about supply and demand). What happened is that they now make vast profits as counterparties for these hedge funds, utilising sharing of superior market knowledge, and the positions held by speculators.

I strongly suspect and I am purely speculating here as I haven't thought this through yet - that post 2004 BP attained a greater measure of control of the Brent /BFO pricing complex and continue to act in close (probably tacit) collusion with Goldman utilising the ICEFutures platform to manipulate markets.

Moreover, I think that they have been able to move on from "micro" short term manipulation to "Macro" medium term manipulation by using a combination of BP's Forties production, and Goldman's speculative GSCI investors as a base to keep the price artificially high.

How "sustainable" is this in the long term?
That ties in to the whole Peak Oil question, of course.

A good example was the 1985 Tin Crisis when the cartel of producer nations which kept the price artificially high eventually ran up against a tidal wave of new production which they could no longer afford to stockpile.

I don't see that happening in crude oil, frankly: sure there is lots of crude oil, but the low hanging fruit is long since gone, and I think that in terms of production levels, this is pretty much as good as it gets.

Demand destruction is another issue, and takes time to occur, but nowhere near as long as new production. If and when the market is in oversupply then the end of this manipulated "Bubble" will happen fast, as it did in the Tin Crisis, and quite likely take the Clearing Houses with it

I hope that all makes sense.

In terms of strategic interests of course the producers (Norway in particular, Russia and many Gulf producers) will be quite happy to see these high prices, and would see the billions made by intermediaries as a small price to pay.

The real losers are the consumers - first and foremost the US, and then China and Japan. The US and China have a common interest on sorting this out.

The US Congress and Senate are looking in the wrong place for culprits IMHO.

Irrespective of the value of position limits as a tool to limit manipulation (where I have my doubts) the embarrassing fact for NYMEX and the US is that the WTI contract is these days the tail, and the ICEFutures BFO contract the dog.

Note that I made no reference (for reasons I will not bore you with) to increasing demand from China etc.

This response was not, at the end of the day, about Peak Oil, and perhaps any comments in relation to that aspect might usefully be directed to another Diary?

Gordon Brown: is that all there is?

has a very interesting theme.

Which is: if you achieve what you set out to do, what then? Is success only a Dead Sea Fruit, which turns to ashes in the mouth?

I found this comparison of Brown and Thatcher an interesting one

Whether Gordon Brown will overcome his current difficulties remains to be seen, but viewed through this lens it is possible to understand why he was so much more disorientated by his transition to No 10 than Prime Ministers such as Thatcher and Churchill. Brown viewed elevation to the Premiership as the be all and end all of his political career: it was the goal towards which he was striving from the moment he conceded the leadership of the Labour Party to his close friend. Anticlimax was inevitable.

Thatcher, on the other hand, was no less ruthless or determined, but her guiding ambition was to change Britain. Becoming Prime Minister was, in her schema, a stepping-stone to a grander destiny. No great psychological adjustment was required until she was ousted from office, losing her raison d'etre in the process.

Is the solution to set ourselves unattainable goals, towards which we can only strive?

The Mother of all Inside Trades is worth publishing pretty much in full, not least because it includes a quote from Diary of mine on the subject of Bear Stearns.

I have my own ideas about what happened here, and no doubt ET'ers will be able to add more.

But on the face of it, it looks as though J P Morgan were able to recapitalise themselves essentially by buying Bear Stearns at a massive undervalue following one of the most egregious cases of market manipulation ever seen.

If this isn't a case for the Senate Sub-Committee on Investigations, I don't know what is.

Washing Dirty Central Bank Linen

It appears that one of the tactics of the Northern Rock litigants in their ongoing claim for compensation from the Bank of England will be to expose in gory detail exactly how much money the Bank of England has actually been making out of its Northern Rock loans.

While it has been assumed that the Rock's eventual return to the private sector will net a profit for the public purse, the profitability of the loan itself has been shrouded in secrecy. A source close to shareholders said: 'We want to get that out in open court.'

Lawyers will also be keen to publicise the fact that the Treasury has received fees from the Rock in return for its guarantee of customers' deposits. It also had about £31m of advisers' fees refunded by the bank.

Now, I am not proud to admit in public my unhealthy addiction to the Financial Pornography of Central Banking, but I did have a couple of Northern Rock based Diaries on the subject, such as

Bank of England - Unplugged

and

Not Northern Rocket Science

Rhetoric and Reality
As I explained, the actual mechanics of Central Bank money creation constitute Financial Pornography which no decent newspaper will print. The FT - uniquely, in my experience - allowed the economist Tim Congdon to expose the truth in fairly clear - if technical - terms.

The Rhetoric of Northern Rock - as being an immense "Drain" on the poor bloody taxpayer - is totally at odds with the Reality, which is that the Bank of England has been "coining it" (pun intended) at the rate of £ tens of millions per week.

The BoE achieves this profit because they have been "over-funding". That is to say, they have been receiving the base rate of >5% (plus penalties) from Northern Rock on loans of up to £30 billion, and have been paying zero percent on the cash balances of Clearing Bank reserves they hold. (as opposed to funding through issuance of Treasury Debt).

An extremely astute commentator has pointed out that one key reason for this course of conduct is that the Debt Management Office ("DMO") - which used to be part of the Bank of England - is now part of the Treasury.

Interbank lending should be used to balance the books of a bank which has lent more than its deposits with the excess deposits (of equal amount) which some other bank must have. (Rules of Double-Entry Bookkeeping state that total debit balances in the banking system will be matched exactly by total credit balances.)

In Britain the balancing used to be achieved, not through the central bank, but through 'Discount Houses', for they alone had access to funds from the Bank of England. The EU rules have changed this. All banks will have excess deposits at the Central Bank if the government is unable to fund its borrowings by replacing loans from the central bank with loans direct from investors. If the government borrows too much direct from investors, it will strip the banks of liquidity. Same if it raises more tax than it spends.

Such a shortage of liquidity is resolved by the Central Bank lending to the commercial banks who deposit the money back with the Central Bank. Mad of course but it happens.

Thus the key to the level of true liquidity is what the government's Debt Management Office (DMO) is doing. The DMO should be under the control of the head of the Central Bank.

In Britain at the moment it is not, the fault of Gordon Brown who stripped the Bank of England of the powers it has used for 300 years.

The profit made from the power to issue Money is known as "seignorage", and is normally only received by Central Banks in respect of notes and coin.

The (political) Treasury simply could not resist the "free" money from seignorage and have now brought the subject blinking in the light out from (neutral) Central Banking darkness.

There are probably fewer than 100 people who actually understand the Reality of Central Banking, and from the tenor and quality of the political debate re Northern Rock, no leading politician is among them.

Lost Knowledge?
There was a time when there was a widespread knowledge and understanding of the methods, rights and wrongs of Central Banking as it has been since John Law's Banque Royale in 1718.

Over the years - the battle having been won by the banking interests (in the US in 1913) - this knowledge died with the protagonists, and the debate has been air-brushed from History, so that all that is now left is the assumption that this is the way it is, and some technical understanding by the people who run the system, who never question its right to exist.

The knowledge has therefore been lost, which was precisely the intention of those in power, and any discussion confined to the tin foil hat brigade.

The Private Life of Central Banking
So the Private Life of Central Banking has long been placed "off limits" in the decent Press and was right up there with the Private Life of the Royal Family, so that anything touching on it has been automatically "spiked", in the way that (say) Prince Philip's peccadilloes always were.

Times Change: and while I do not expect to see banking matters splashed interminably over "Hallo" magazine, it may just be the case that the financial press may be about to open up the Private Life of Central Banks.

A Lady Chatterley Moment?
The literary "Pornography" floodgates opened in 1960 in the famous UK obscenity case re D H Lawrence's

Lady Chatterley's Lover

- the killer moment being the prosecution barrister's classic...

"Is it a book that you would even wish your wife or your servants to read?"

It's possible that the litigants are hoping the government will stump up to avoid having this Financial Pornography aired, but I doubt whether this motivates the litigants. Even if that were the case, I doubt whether the government will be embarrassed about it, because no one has thought twice about the rights and wrongs of the system for generations.

So perhaps we might see a similar Lady Chatterley Moment in relation to the Financial Pornography of "deficit-based" Central Banking.

If so, this may actually open up the possibility of public discussion of alternatives to a fundamentally unsustainable system.

Bear Raid

The source is a blog run by an options expert by the name of John Olagues.

The allegation is that someone bought massive amounts of deep "out of the money" Bear Stearns "Put" stock options in the run up to the collapse.

What this means is that they acquired the right to sell Bear Stearns stock at a price far below the then current price of $70.00 per share.

In this case at $17.50 at $15.00 and even at $10.00.  

If the price remained above this figure by the time the option expired, the buyers of the "Put" would have lost the premiums they paid. But as we know now, it didn't, and actually collapsed to $2.00.

In order to do this, they had to ask the relevant exchange to open new "series" of option "strike prices"  at price levels way below anything in existence, I think.

There is nothing unusual for an option exchange to do that - particularly for dates well into the future - but the thing about this alleged market coup/ trading scam is that the expiry date for the requested series were relatively close by, in April, and evn March - which had only days to run.

As the article explains, this fact means that the "time value" of the options was therefore minimal, and the leverage vastly increased.

Essentially these people were betting on an "outsider" they knew was going to win....

The introduction of those far-out-of-the-money put series in the April and March months immediately before the crash provided a vehicle whereby extreme leverage was available to the insiders.

In other words if an insider had $100,000 and he knew that Morgan would buy Bear Stearns at 2, he could make 5-10 times more on the $100,000 by buying the newly introduced March puts. This is so because the soon to
expire far out-of-the-money puts were far cheaper than the July or October out-of-the-money puts.

And that is why the illegal inside traders requested the exchanges to introduce the far out-of-the-moneys just days before the crash.

As a former regulator myself, I would be crawling all over these trades.

The sheer greed and blatancy of this - if it is what happened - is absolutely staggering.

One question that occurs to me is who actually sold these Put Options? And why aren't they creating merry hell about the losses?

Where is Spitzer when we need him?

Peak Credit and a Flight to Simplicity

and for those of you who are dazzled by the flashing ads on that site the text follows.

Peak Oil - the theory that we may be at or near a peak level of oil production - while remaining controversial is at least now respectable. But is the continuing credit crash masking another inconvenient truth? Might banks now be experiencing the aftermath of peak credit?

What is a bank anyway? They are actually credit institutions. They create the credit - as interest-bearing loans - which constitutes the life blood of the economy. This credit actually is the bulk (or more than 97%) of the money in use in the US, the rest being notes and coin.

Banks stand between borrowers and depositors: they extend credit to borrowers and receive credit from depositors. So they are also middlemen or credit intermediaries.

Promoted by Migeru

I'm using the material as source for a series of articles aimed at newspapers.

The Future of Compliance: Part One - Peak Credit

Mar 28 2008

Surveying the aftermath of JPMorgan's dramatic acquisition of Bear Stearns and the impotence of the Federal Reserve's "conventional" monetary solutions, it is clear that dramatic, and unprecedented, events are unfolding. Since this is a dynamic process, any commentary is subject to be contradicted within 24 hours, resurrected as conventional wisdom in a week, and dispatched to the outer darkness of history within a month. Whatever the outcome, however, some of the regulatory issues have been evident for some time and others are now emerging.

This article is the first of two concerned with the effect of current developments upon the world of compliance. Despite the kind of special pleading currently seen from the likes of Alan Greenspan, the former chairman of the US Federal Reserve, the effects of this regulatory disaster can only be a call for a retreat from the process of deregulation many commentators regard as responsible.

To predict where the compliance industry goes from here it is necessary to outline the events and trends which constitute almost tectonic movements in the financial markets. To do so, compliance is approached as an essential form of market "quality control".

Peak credit?

The subject of "peak oil" is usually misrepresented to mean "oil is running out" but in fact means that, "while there may be plenty of oil in the ground, there is a maximum (peak) level of production which we may even have reached". Peak oil has gradually evolved from a wild "crank" theory to the relative respectability of -- a well-known phrase -- an "inconvenient truth".

The consequences of peak oil are not within the scope of this article but serve as an analogy for another phenomenon -- peak credit, which, like peak oil, may in fact already have occurred.

Banking

A bank is a credit institution with a monopoly privilege to create credit backed by an amount of regulatory capital set by the Bank for International Settlements (Basel Accords I and II). The interest-bearing loans or credit which banks create is actually the money we use, and this keeps the economic world turning on its axis. Credit institutions create this money which is then instantaneously re-deposited back into the banking system. Without this flow of new credit there would be no development and no economic growth.

It should be noted at this point that most people -- even the most financially sophisticated -- are under the misapprehension that what banks do is to first take in deposits (i.e., pre-existing money) and then, second, loan them out again. This is actually what credit unions do and what "licensed deposit takers" (prior to the Financial Services Act) used to do. The fact is, however, that credit institutions (aka banks) actually create loans first as new money which become deposits second. There is intense competition among banks to gather in these deposits at an advantageous rate of interest.

Credit intermediation

There are two types of credit:

    * "Trade" credit -- extended by a seller to a buyer and familiar to anyone involved in bilateral over-the-counter markets.

    * "Bank" credit -- extended by a bank to a borrower and by a depositor to a bank.

The economic role of a bank is to stand between or "intermediate":

    * Borrower -- someone who is receiving something of value from the bank and promising to provide something of value in the future; and

    * Lender -- someone who is giving something of value in exchange for a promise from the bank to provide something of value in the future.

If we deconstruct this relationship we see that the bank is guaranteeing the credit of the borrower. The charge the bank makes for doing so (interest) must cover interest paid to depositors, the bank's operating costs and the costs of defaults, and will hopefully thereby provide an additional margin as profit.

In other words, the credit itself does not cost anything to create. It is the guarantee function that is the economic value provided by the bank and this implicit guarantee is supported by the pool of "regulatory capital".

Asset-based and deficit-based finance

As credit involves a "promise to pay" and as "debt" constitutes one of the "twin peaks" of financial capital, credit may be thought of as "deficit-based" finance. The other peak is "equity", which involves actual "ownership" of productive assets in legal vehicles.

Historically, this has been the "joint stock limited liability company" or "corporation"; however, there are an increasing number of alternative vehicles such as trust and partnership-based vehicles, which together may be thought of as "asset-based" finance. The problem is that the bulk of financing of productive assets globally has been a hybrid,

i.e., for the most part, it consists of credit that credit institutions have created and secured by a legal claim over productive assets that the borrower owns.

Deficit-based finance that is "property-backed", i.e., mortgage loans, underpins in excess of two thirds of the money which the Federal Reserve Bank and the Bank of England issues.

Asset bubbles

The first credit-fuelled "bubble" was the one that the remarkable Scot, John Law, instigated in France, when he created the first example of a central bank in recognisably modern form in 1718 -- the Banque Royale -- and used it to fuel a massive speculative bubble in the share price of the French Mississippi Company (Compagnie des Indes).

Since then, a never-ending series of financial bubbles has been a recurring phenomenon in the financial markets and all bubbles have involved the excessive use of deficit-based finance by investors to buy productive assets.

The result is that asset prices lose touch with the reality of the underlying revenue flows that the assets have generated. Inevitably, the asset price reaches a level at which no further borrowing is possible and the asset price collapses, taking the borrower, and often, the banks which deficit financed the bubble with it.

The pyramid of cheap dollar-denominated credit built in recent years upon US land rental values is such that the current process of "de-leveraging", which has only just begun, is, at worst, in danger of sucking the US into a depression or, at best, a Japanese-style economic stasis.

Some would argue that the credit level created in the US reached an unsustainable peak some months ago and that a fundamental restructuring -- a Bretton Woods II -- is now necessary.

The role of banking innovation

The main issues have been the emergence of new financial techniques, and the re-emergence of old ones, and the regulatory response to these. In recent years banks have been increasingly able to "outsource" to investors the risks of their implicit guarantee. This risk transfer has occurred in three principal ways:

    * Securitisation -- permanent transfer.

    * Credit derivatives -- temporary transfer for a defined period.

    * Credit insurance -- partial transfer.

There has also been a massive growth of complex structured products that involve the "dicing and slicing" of risk.

The regulatory risks inherent in securitisation are not new. These were the principal reasons for the separation by the Glass-Steagall Acts in 1933 of investment banking and commercial banking in the aftermath of the US stock market bubble which led to the 1929 Wall Street Crash.

There have already been calls for the reinstatement of this separation and these calls are likely to grow stronger both as the current crisis unfolds and as lessons are digested in the aftermath, whenever that begins.

Clearly, there will be a reappraisal of the other risk transfer mechanisms as well. In particular, the capitalisation of "monolines" and the risks they undertake in ensuring credit risk will be the subject of intense regulatory scrutiny.

Credit derivatives have proved too useful a tool to be destined for oblivion, unlike most of the financial "toxic waste" now gravitating towards the Fed silo. There may be an increased emphasis on transparency, however, and a drive towards standardisation of terms.

Rating agencies

The role of rating agencies and, in particular, the commercial conflicts of interest between the shareholder owners of such agencies and some of the market participants who rely on their neutrality, has already come in for considerable debate and discussion.

This debate is expected to continue and the relationship between regulators and agencies will be reviewed. One radical approach might be to encourage the evolution of a new generation of rating agencies that operate on a not-for-profit basis.

Asset-based finance and 'unitisation'

New asset-based financial tools are continually evolving. For example, the emergence of "income trusts" and "royalty trusts" in Canada has created an entirely new asset class of "units", which comprise rights to part of the gross revenues of listed corporations that have been attractive to long-term investors, such as pension funds who see an advantage in accessing corporate revenues before the management does.

The recent Blackstone IPO was not dissimilar, in that it was not a sale of conventional shares but a sale of partnership interests in Blackstone revenues.

Other growing forms of asset-based finance are: exchange-traded funds; real estate investment funds; and Islamic finance, which is inherently asset-based albeit some of the current generation of "sukuk" vehicles do not necessarily share risk and reward in a way that most Muslims would consider ethical.

Asset-based finance may also be used as a replacement for the increasingly scarce availability of deficit-based, but asset-backed finance. This will continue to be the case at least until banks' balance sheets have been repaired, which -- as we have seen in Japan -- may be a very lengthy process, and moreover, a process that cannot even begin until the market has stabilised.

Governments and guarantees

The contrasting approaches of the US regulatory system, which the Fed drives, and the fragmented "tripartite" (HM Treasury, Bank of England and the Financial Services Authority) approach in the UK have been brought home by the marked difference in the protracted Northern Rock saga and the blitzkrieg approach of the Fed to Bear Stearns.

Decisiveness is all very well of course but the political ramifications, in particular, the democratic accountability and transparency of both the Northern Rock and Bear Stearns "rescues", require careful study.

It is possible to imagine a new approach to the roles and responsibilities of national financial regulators, treasuries, monetary authorities and central banks. Indeed, it is even possible to question the necessity of a central bank at all -- Hong Kong, for instance, has never had one.

The challenge of napsterisation

The next article will consider the continuing and profound changes which flow from the pervasive spread of the internet and, in particular, the effect that the arrival of peer-to-peer direct connectivity ("napsterisation") is already having on the legal and financial structure of markets.

Markets are becoming globally networked; however, regulation remains firmly bound to disparate national jurisdictions. Regulation that is appropriate for intermediaries is entirely redundant for the regulation of "end user" market participants on the one hand and the emerging breed of market service providers on the other.

It is here, in the current transition from "transaction-based" markets that involve intermediaries in a new generation of globally networked markets based upon new forms of service provision, that new opportunities and challenges lie and the compliance industry will be at the heart of this transformation.

entirely idiosyncratic "rap" on the merits of their flat in Oslo.  

It's in Norwegian of course, but that isn't really the point!

I hardly think Norwegian estate agents (which barely existed 20 years ago) are quivering in their boots - but it does open up some new ideas for a "Property Channel".

Get on it, Sven!

Light entertainment for a lazy Saturday afternoon - Diary rescue by Migeru

Ahmadinejad in Baghdad

The article adds credence to the view

Yet in Tehran, DEBKAfile's Iranian sources report, the president's excursion into US-occupied territory was counted as a step forward in its seven-month old secret Saudi-mediated dialogue with Washington.

This dialogue has advanced in give-and-take steps on a broad set of issues.

that - as has been obvious for some time - the US and Iran started to develop some sort of accommodation around August of last year.

The most prominent is Iran's nuclear program. The third round of UN Security Council sanctions imposed Monday, March 3, banning trade with Iran did not really bother Tehran. The penalties were predicted and anticipated. Iran's rulers can live with a motion which they see as the Bush administration's parting shot in the dispute over the uranium enrichment issue. Not surprisingly Israel was not satisfied.

But mostly they are looking ahead to the next US president and their objective is clear: the cementing of the incumbent White House position on the North Korean nuclear weapons status as a convention which its next tenant will apply to Iran. This in rough terms means accepting a Tehran guarantee to freeze its uranium enrichment process, its nuclear bomb program and nuclear-capable ballistic missile project, without demanding their dismantlement.

This outline would be deemed in Tehran a positive basis for a nuclear deal with Washington.

Coming from an Israeli publication, there is, unsurprisingly, an assumption that there is a nuclear bomb program. My own view (based upon personal experience of the void between rhetoric and reality in Iran) is that if that is the case, it is not in fact deliverable in under 10 years at a minimum, and longer under a meaningful sanction regime.  

What does the Bush administration expect from Tehran?

According to our Washington sources, George W. Bush is keen to hand his successor a relatively stable Iraq where the violence spiral sustains its downward curve. The US president accordingly stopped direct US military action against pro-Iranian Shiite "special groups," in the expectation that Tehran will use its influence to keep Iraq on a relatively even keel for the remainder of his term in office.

The quid pro quo runs like this: Tehran is bidding for an understanding with Washington on its nuclear program, while the US is after Iran's help to preserve the status quo in Iraq.

Iran has two powerful resources for delivering the goods:

1. An extensive clandestine intelligence and military infrastructure across Iraq that will obey Tehran's orders to pull in its horns.
   
2. Tehran's hand on the spigot of the flow of weapons, money and extra-powerful roadside bombs to the different anti-US insurgent groups.
   

 

This seems to be the most objective bullshit -free assessment I have seen in a long time with a strong ring of truth.

And now to the nitty gritty: oil.

The third key issue dominating the US-Iranian dialogue is southern Iraq and its oil. This is also pivotal for Iran's bilateral relations with Iraq.

Ahmadinejad's hosts in Baghdad have to live with the realization that their guest has more clout with the Shiites of southern Iraq than the Maliki government.

Tehran's dominance of southern Iraq has three focii:
The shrine-cities of Karbala and Najef and the oil port of Basra. Iran and the radical Iraqi Shiite cleric Moqtada Sadr at the head of his Mehdi Army militia divide control of these three cities between them.

If the central government wants any say in southern Iraq, it must stay on good terms with both its rival masters.

Again, that seems a pretty credible assessment to me of the realities on the ground in Southern Iraq.

During his last visit to Tehran at the end of last year, prime minister al-Maliki signed an agreement to lay a pipeline taking Iraqi oil to Iranian refineries in Abadan.

This was a bid to link southern Iraq's oil to the Iranian oil fields and installations on the eastern bank of the Shatt al-Arb opposite Basra.

The Americans, who control and defend the southern oil fields, let the agreement go through, although they are in competition against Iran in Central Asia and Turkey. The Bush administration is reconciled to including southern Iraq and its oil fields in the overall package of Iraq understandings with Tehran.

Despite the "Iranian hegemony" propaganda, the US knows that Iran has never had any territorial ambitions (other than the odd maritime border dispute) over Iraq - merely a desire for security guarantees.

I would be interested to know exactly what form of goods and services will be provided to Iraq by Iran under the $1bn credit announced during the Baghdad visit. I would be surprised if oil equipment weren't part of it.

It's a long way from being over, but if August last year saw the End of the Beginning in Iraq, this visit by Ahmadinejad might be the Beginning of the End.

And is it the Saudi's wot done it?

That would be entirely consistent with my own experience with the Middle East Exchange (morphed to the infamous "Iran Oil Bourse") I initiated in mid 2001, which was apparently vetoed by the Saudi's, only for them to withdraw the veto a couple of years post 9/11 when the US/ Saudi relationship became more "arm's length".

The fact is that the Saudi's OPEC dominance means that the Iranians have always listened closely to what they have to say.

So we had this extract in the Sunday Herald today.

I for one have never ploughed through anything by Smith, or come to that any of the "greats", and am therefore reliant upon the perspective, values, accuracy and good faith of those commentators who have.

O' Rourke's book looks promising, I must say, if the extract in the Herald is anything to go by.

A few gems follow: firstly, for our US friends...

Some acolytes of Smith might be surprised if they ever read him. He wrote that "the oppression of the poor must establish the monopoly of the rich", and that profit is "always highest in the countries which are going fastest to ruin".

For those persuaded of the need for a tax on land values, the following might indicate support from Smith....

Adam Smith was tough on the landed gentry: "As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed."

He would have been amused to see the dukes and duchesses of England reduced to keeping circus animals and other attractions on their great estates and letting fat daytrippers waddle through their stately homes, camcording the noble ancestors on the walls.

But it was this nugget that persuaded me that Adam Smith would have been well at home in ET's occasional Anglo Disease series....

Smith was tougher yet on the very people who, in his time, were beginning to generate the wealth of nations that he proposed to increase. Despite his friendship with merchants and manufacturers in Edinburgh and Glasgow, Smith had a cool loathing for the class: "Masters are always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labour.

"Our merchants and master-manufacturers complain much of the bad effects of high wages in raising the price of their goods both at home and abroad. They say nothing concerning the bad effects of high profits.

They are silent and regard to the pernicious effects of their own gains. They complain only of those of other people.

And as for the privatisation mania, Smith had no time for the East India Company's depredations in India...

And Smith was no enthusiast for the privatisation of government functions. Concerning the East India Company and its rule of Bengal, Smith wrote: "The government of an exclusive company of merchants is, perhaps, the worst of all governments for any country whatever."

Finally, and fairly crucially, was Smith's distinction between (acceptable - indeed necessary, in his view)"profits" and "pernicious gains".

Smith wanted "the establishment of a government which afforded to industry the only encouragement which it requires, some tolerable security that it shall enjoy the fruits of its own labour". Smith did not consider profits to be the same as "pernicious gains".

Now my own distinction between "acceptable"  and "pernicious" profits is that between those profits achieved by the producer, and those by the "rentier".

The reason I am hopeful that there is a way out of the deep hole the financial system is in, is that there are new forms of finance capital now emerging to replace the "pernicious" tools of finance capital - ie Debt and "Equity" - which are IMHO the direct causes (with private property in Commons) of the Anglo Disease.

Fred Harrison is a leading, and eloquent, "Georgist" - that is to say a proponent of the ideas of one of the greatest political economists of the 19th Century - Henry George.

His seminal work Progress and Poverty made him the second best known person in the US after the President but George has essentially been "airbrushed" from History by the proponents of conventional political economy and their domination of discourse in both academia and media.

George proposed a "Single Tax"  - a tax on the privilege of exclusive "ownership" of the Commons of land - and in this video Harrison outlines the rationale for a re-basing of taxation away from income, towards "wealth" through the use of this mechanism.

I do not believe that many people can actually deny the equity (although they may certainly resist the application in their own case!) of the principle that those who have exclusive private use of "Commons", such as Land (Real Property) and Knowledge (Intellectual property) should compensate those they exclude.

Strangely enough, this concept is non-ideological, having in its time been attacked from the Left and the Right, both on the basis of their own assumptions.

The heyday of the idea was at the turn of the 20th Century when the Liberals under Lloyd George enacted it only for that Act to be overturned by the House of Lords.

That pivotal constitutional battle in turn led to the emasculation of the House of Lords, but not soon enough to revive the concept after the chaos of the First World War and the political upheavals which followed it.

The logic of Harrison's case for Land Value Tax is IMHO unassailable, and indeed the guru of the neoCons himself - Friedman - regarded it as the "least worst" tax. Moreover, the concept is regarded with favour by commentators including Sam Brittan and Martin Wolf of the FT, and constitutes one of my few areas of total agreement with the latter.

For my part, I think it will be possible to implement the principles of the tax in another way through a new approach to property rights possible through the application of a new legal and financial structure or "enterprise model" to land.

I wrote to the Governor of the Bank of England asking about where the Bank's money for Northern Rock came from, and was it created out of nothing.  

The reply ....(from an acolyte)....  claims the money comes from " 'reserve balances which is money held by the banking system in accounts at the Bank....".

Note that these reserve balances are essentially interest-free loans by the clearing banks to the Bank of England.

There was then this startling admission

"These balances are a form of 'central bank money' and the Bank has taken steps to offset the creation of central bank money by lending less in its regular market operations than it would otherwise have done."

that the banking system is being starved of liquidity as a result of the (hugely profitable) harvesting by the Bank of England of "seignorage" in respect of its loans to Northern Rock. These profits arise out of the fact that the Bank of England is lending to Northern Rock at base rate (plus an accumulating penalty payable in due course to the Treasury) money which it is funding at zero cost.

ie as pointed out twice in the FT by Tim Congdon, and documented here, the truth of the matter is that the more that is lent to Northern Rock in this way, and the longer these loans go on, the more money the long-suffering "tax payer" will actually make through the resulting Bank of England profits, provided there are no defaults.

Bu what if there were defaults?

So, all in all, there is an admission that the money was created by the Bank and the fun really will come if the money gets lost by Northern Rock because I happen to know that somebody has written to the Bank asking how that loss would be written in the Bank's accounts..........Watch this space....---

Again, we have discussed in ET at some length the effect upon the system and the poor bloody taxpayer of a default by the Northern Rock in its loans from the Bank of England.

My view is that the taxpayer would suffer no loss at all, and that the actual monetary effect of such write offs would be zero.

Now, on to a slightly different question , relating to the effect of government borrowing in itself.

....in response to another question the acolyte says that Article 101 of the Maastricht Treaty makes it illegal for central banks to provide loans to governments.

Er hem -- except when it's Northern Rock, of course.

But I asked about lending to the government in the context of loans to governments for public capital projects (thereby halving or more the cost of the projects).  So you can see how the banking system has worked to stitch up everything so that all lending is always done at interest -- even lending for hospitals.

And, of course,  the acolyte, said that lending to a government "could be inflationary".

Which brings us to the key fallacy at the heart of our monetary system, which is the official - unassailable and undiscussable - position that the creation of money - ex nihilo - by private bank lending at interest is by definition less inflationary than the creation of money ex nihilo by Central Banks without an interest burden.

In my view, Central Banks and all other banks are - like all other intermediaries in the age of the Internet - no longer necessary.

The point is that credit in itself costs nothing to create: the real value provided by the banking system lies in the guarantee provided (and backed in the case of private banks by an amount of "regulatory capital").

Unfortunately, this guarantee function has essentially been opaquely "outsourced" by the banking system either totally (securitisation); partially (credit insurance) or temporarily (credit derivatives) with the result being the ongoing "Credit Crash" which is in its first (driver hitting the windscreen) phase.

I believe that it is essential, and actually, quite straightforward, to reconfigure the credit markets to establish an alternative disintermediated mutualised structure.

I don't have the Financial Statistics Table 4.2A he refers to, and probably would have difficulty interpreting it if I did!

How daft can Central Banks get?

I attach the latest table 4.2A from the Financial Statistics. It shows the Bank of England balance sheet post the loan to Northern Rock.

You will see that the Bank has financed the loan to a very large extent by cutting back on Open Market Lending. In other words it has stripped the rest of the banking system's liquidity to the extent of the advance to Northern Rock, and as a result the latter cannot be repaid!

For the love of Mammon! - promoted by Migeru

My question is: do they have any choice?

Or is another symptom of the Anglo Disease the fact that the retail depositor is a dying breed, and that the people in whose hands wealth is concentrating don't tend to have a deposit account with the Chipping Sodbury Building Society?

I find this an interesting and depressing comparison.

The group said UK lenders had traditionally used savings deposits to fund their mortgage business, but raising money through the wholesale markets had become increasingly popular in recent years.

It said during 2000 wholesale markets accounted for an average of just 27.8% of all funding, but by the first half of 2007 this had nearly doubled to 47.8%.

Scratch my head as I might, I really cannot see any way - in the current paradigm - how this trend could be reversed.....

Robert Peston, the BBC business editor has always had the Inside Track on Northern Rock, so that we see after a week of dithering Gordon has finally decided to bail out the shareholders.

Or rather, that's what it looks like at first blush.

Prime Minister Gordon Brown has backed a plan from bankers Goldman Sachs to convert the Bank of England's loans to Northern Rock into bonds for sale.

These bonds would stay on the public sector balance sheet until conditions improve in financial markets.

They would then be sold to investors in small parcels every few months.

The sales would take place as and when financial institutions regain their appetite for such investments.

And they would be guaranteed by the government, rather than by a private sector insurer.

They would use a special purpose vehicle as a "wrapper" for this "securitisation"

Under the Goldman Sachs plan, the Rock's assets would be put into a special purpose vehicle.

This special purpose vehicle would then sell bonds over the coming months and years, as markets recover.

The key questions are:

(a) what rate will these bonds be paying?

(Since this constitutes a major part of Northern Rock's funding costs, and directly affects their profit); and

(b) what will the Government get for their guarantee?

(Again, a cost affecting shareholders)

As Peston says

On those terms, it will be difficult for Northern Rock not to agree a deal with either the Virgin consortium or Olivant - the private sector groups vying for control of Northern Rock.

But what about the "tax-payer"?

Taxpayer exposure

In theory, this would gradually reduce the taxpayers' exposure to the Rock.

A substantial taxpayer exposure, of tens of billions of pounds - in the form of direct loans and guarantees to other lenders and depositors - could remain in place for years. However the Rock would be expected to pay a fee to the government in return for this substantial support

Well: maybe.

We have discussed in detail on ET exactly what effect on the poor bloody taxpayer a default would have. Personally I believe that what the taxpayer has never had, the taxpayer would never miss.

ie the effect would be the same as burning a few skip loads of time-expired bank-notes.

However, some on ET believe the effect would be inflationary.

I don't see how defaults (which essentially destroy money) can be inflationary.

The government may well be attacked by opposition parties for subsidising what could turn out to be vast profits for any future private sector controller of the Rock, such as Sir Richard Branson's Virgin Group.

Dead right. This is potentially the original "licence to print money".

Whatever the effect on inflation, this is a potential goldmine for Branson's Virgin or Olivant. And if it isn't, they simply won't do it.

There must be another way.

The point ignored in all this (in fact, almost deliberately concealed) is that Bank of England credit costs nothing to create, and the "seignorage" on the money minted by the Bank of England to loan to Northern Wreck has been rolling in at the rate of £25m a week plus. These seignorage profits actually will in due course accrue to the tax-payer, as they do now in respect of banknotes in circulation.

The real value provided by Banks aka Credit Institutions (beyond clearing system administration) is that of a guarantee, and they back this guarantee with a pool of Capital as required by the Bank of International Settlements.

The Bank of England, on the other hand, backs their guarantee with nothing at all other than trust and faith.

A Northern Rock Partnership?
No prizes for guessing what I think should be done instead. In my view, a fee should be paid by Northern Rock to the Government for the use of the guarantee into a "Default Pool", and this accumulating fee should form Equity ranking alongside that of the existing shareholders.

This could be accomplished by putting the assets into the hands of a Trustee/Custodian - where most assets are already (quite unknown to the beneficiary of the Trust - the Northern Down's Syndrome Association!), via the opaque "Granite" SIV.

An LLP could be used as a framework / Special Purpose Vehicle for what would be a revenue sharing "Capital Partnership" between Investors and Managers instantly recognisable to Islamic investors.

In this way:

(a) the risks and rewards could be shared equitably, which I would bet my bottom dollar they will not be in the bailout as proposed by Goldman;

(b) there could be a single asset class consisting of proportional "units" or "nth's" in Northern Rock's net revenues after a provision is made into the Pool.

It will be interesting to see what the Northern Rock share price does on Monday.....

This was well deconstructed by Professor Michael Hudson in the gang8 list in which I am a member. Unlike me he is a polymath well able to defend his corner academically, and he also happens to be Kucinich's economic adviser.

The following may therefore be of interest to ET'ers....

Roach: The US has been the main culprit behind the destabilising global imbalances of recent years. America's massive current account deficit absorbs about 75 per cent of the world's surplus saving.

Hudson: This is nonsense. The U.S. balance-of-trade deficit and U.S. foreign investment pump dollars into foreign exporters and sellers of raw materials. The exporters and other dollar recipients turn over these dollars to their central banks for domestic currency or other non-dollar currencies. The central banks then end up with these dollars  and until recently they have invested them in U.S. Treasury bills, although they are now looking to buy "hard assets" (mineral resources in Africa, companies in Asia) as they see that the United States has no ability  much less, willingness  to pay these U.S. Treasury debts.

U.S. consumers spending abroad is NOT saving. The money that comes back is a dollar glut, NOT foreign "income less consumption". Balance-of-payments accounting thus confuses the usual quack-macroeconomic national income observers.

Most believe that a weaker US dollar is the best cure for these imbalances. Yet a broad measure of the US dollar has dropped 23 per cent since February 2002 in real terms, with only minimal impact on America's gaping external imbalance.

Roach: Dollar bears argue that more currency depreciation is needed. Protectionists insist that China - which has the largest bilateral trade imbalance with the US - should bear a disproportionate share of the next downleg in the US dollar. There is good reason to doubt this view. America's current account deficit is due more to bubbles in asset prices than to a misaligned dollar. A resolution will require more of a correction in asset prices than a further depreciation of the dollar. At the core of the problem is one of the most insidious characteristics of an asset-dependent economy - a chronic shortfall in domestic saving.

Hudson: Here again, the Big Lie of the financial sector's con game. There is NO shortfall in domestic US saving. Gross saving is as high as ever. But only the wealthiest 10 percent are doing it  and are lending it out to the bottom 90%. When savings are lent out as debt, the result is a wash. This is NOT the case when savings are invested in tangible new means of production. That represents a build-up of equity. But that is not occurring today.

So the real problem is that saving is taking the form of loans,not equity investment. This is precisely what the St. Simonians explained in France from the 1820s through 1860s. And for that matter, what Islam pointed to a millennium earlier.

(And, for that matter, what I am pointing out now, except that I advocate the extension of Equity to include new forms of investment in land, property and renewables among other things: ChrisCook)

The solution, according to financial lobby Stephen Roach (Chairman of Morgan Stanley Asia), is more tax breaks for the ultra-rich who do the saving. The problem is that they also do the indebting. Their credit finds its counterpart in the rest of the economy's debt. It takes the form of corporate stock buybacks, junk bonds issued by corporate raiders or for M&A activity, junk mortgages, and increasingly, junk credit-card debt now that defaults and bankruptcies are beginning to soar. (Today, AT&T announced lower earnings as phones are being turned off all over the United States for non-payment.)

Roach: With America's net national saving averaging a mere 1.4 per cent of national income over the past five years, the US has had to import surplus saving from abroad to keep growing. That means it must run massive current account and trade deficits to attract the foreign capital.

Hudson: Another confusion. It is the trade deficit that produces the savings that foreign central banks recycle back to the US. Roach confuses the direction of causality.

Roach: America's aversion toward saving did not appear out of thin air. Waves of asset appreciation - first equities and, more recently, residential property - convinced citizens that a new era was at hand. Reinforced by a monstrous bubble of cheap credit, there was little perceived need to save the old-fashioned way - out of income. Assets became the preferred vehicle of choice.

Hudson: Yet another misrepresentation. New homebuyers faced a choice: miss out on home ownership and continue renting  at rising prices  or take on a lifetime of debt. Tax cuts for property have left a larger land rental value to be capitalized into yet larger loans.

So the financial sector's campaign for property-tax cuts have fuelled the mortgage bubble, coupled with Alan Greenspan's flooding the economy with enough money to drive down interest rates, lengthen maturities to zero-amortization loans, make zero-down-payment loans, "liar" loans with no confirmation of income, and repeal of federal regulation over bank mortgage lending. Mr. Roach's company made billions of dollars packaging junk mortgages. And now he demands more tax cuts for "savers" - his financial sector clients.

Roach:With one bubble begetting another, America's imbalances rose to epic proportions. Despite generally subpar income generation, private consumption soared to a record 72 per cent of real gross domestic product in 2007. Household debt hit a record 133 per cent of disposable personal income. And income-based measures of personal saving moved back into negative territory in late 2007.

None of these trends is sustainable. It is only a question of when they give way and what it takes to spark a long overdue rebalancing. A sharp decline in asset prices is necessary to rebalance the US economy. It is the only realistic hope to shift the mix of saving away from asset appreciation back to that supported by income generation. That could entail as much as a 20-30 per cent decline in overall US housing prices and a related deflating of the bubble of cheap and easy credit.

Hudson: This is what I call debt deflation: Debt service diverts income away from spending on goods and services.

On the one hand we have the rational scientists, and on the other those who believe science may be extended into the realm of spirituality.

<And that's without even mentioning "Art"!>

I'm going to chuck two things into the Pot. Firstly a very lazy quote from a blog concerning Robert Pirsig's
Metaphysics of Quality

The Metaphysics of Quality (MoQ) is an intellectual ordering of experience; it is a way of organising our knowledge; it is a filing system for the contents of our mind.

It postulates that the fundamental reality is Quality or value. All things come from Quality, and it is Quality that draws all things into being from Quality. All that exists is a form of Quality, and nothing exists without Quality. You could say that Quality is one of the names of God.

The first distinction that is made in understanding Quality is a distinction between Dynamic Quality (DQ) and Static Quality (SQ). DQ cannot be named and cannot be described. It is the cutting edge of experience. It is pre-intellectual awareness. DQ does not fit into any intellectual system; it is the ragged edge at the border of all such systems. DQ is the driving force of evolution, the lure (or: telos) which all of existence pursues.

Sometimes, a DQ driven evolution creates an evolutionary leap. Something new comes into existence. For this new thing of value to be maintained in existence it must 'static latch'; that is, it must be able to generate a particular pattern of value which persists over time, either on a continuous basis or a continuously regenerated basis.

These static latches form the known world. They are the stable forms of Quality.

Static Quality can be named. It can be classified and analysed. The principal classification of SQ is a division into four levels. These levels are discrete and do not overlap. Moreover, all that we presently know can be classified and described according to these four levels, except for DQ itself, which, to repeat, remains outside of all realms of classification.

The four levels are: inorganic, organic, social and intellectual. (For the sake of simplicity the inorganic can be taken to include the quantum level, although perhaps this level could constitute its own 'zeroth' level).

The inorganic level refers to atomic and molecular behaviour. Any object can be viewed as existing at the inorganic level. For example, a rock is a pattern of inorganic value - it's constituent parts value their current relationships more than any other alternative (eg disintegration). In the original flux, before there was either matter or time, Quality was found to lie in a certain structuring of quantum forces. [Here an astro-physicist can fill in the gaps].

The inorganic level is shaped by the laws of physics. These laws are a codification of the value choices made by atoms and molecules.

The organic (or biological) began to develop when a particular molecule made a DQ leap into a different pattern of behaviour. 'Biological evolution can be seen as a process by which weak Dynamic forces at a subatomic level discover stratagems for overcoming huge static inorganic forces at a superatomic level.' The highest quality static latch at the organic level was the molecule DNA. In practical terms this level can be considered as anything which can be described with reference to DNA.

The organic level is shaped by the law of natural selection. This law is a codification of the value choices made by organic patterns of value.

Uniquely (so far as we know), the human species is able to experience two further degrees of static quality.

The social level is the 'subjective customs of groups of people'. This sense of 'social' does not apply to anything non-human. The DQ innovation and static latch which enabled the social level to come into being was the development of language. It is possible that this static latch was supplemented by the further DQ innovation and static latch of ritual, but that is a moot point.

The social level encompasses an enormous variety of human behaviour. It can be understood through the values which govern it. The social level is shaped by laws, customs, mores and religious practices (eg against murder, adultery, theft) which are enforced by soldiers, policemen, parents and priests. These laws are what preserve the existence of social patterns of value from a degradation into the biological patterns of value on which the society depends. The social level is also ordered through the celebrity principle, which articulates the governing social values. Celebrities are those people who exemplify the values of the society, and who gain social rewards (principally wealth, power and fame) as a result.

The intellectual level is 'the level of symbolic social learning', the 'same as mind'. It is the 'collection and manipulation of symbols, created in the brain, that stand for patterns of experience'. The DQ innovation and static latch which enabled the intellectual level to come into being has not been satisfactorily determined.

The intellectual level is shaped by the notion of 'truth', which stands independently of social opinion. There is no link between celebrity and truth. The guardians of the intellectual level are, variously, the members of the Church of Reason. Intellectual 'laws' (eg logic) are a codification of the value choices made by intellectuals.

A culture is a combination of social and intellectual patterns of value. The twentieth century can be understood as a contest between social and intellectual patterns of value.

So: a quick recap on the key terms.
Quality - source of everything (I think of Quality as being one of the names of God, ie it conveys something about God, but is incomplete).
Dynamic and Static Quality - the first division in our understanding. Dynamic Quality (DQ) can't be defined (the Tao that can be spoken is not the eternal Tao). Static Quality(SQ) is everything that we can talk about.
The four levels: inorganic, organic, social and intellectual, in order of ascending value.

My heresy is that I don't think level four is `intellectual' - and I think there are all sorts of profound problems with it. I would rechristen the fourth level as `eudaimonic', and understand how it works differently - and I've written a longish essay on why which can be accessed via the moq.org website.

Pirsig's Metaphysics - in my view - asks better questions of Reality than anything else I have seen - albeit my exposure to Metaphysics is limited. There's also an interesting analogy with Maslow's hierarchy of needs here, of course.

Note that Pirsig confines himself to four levels, and the diarist - who is from a Christian tradition - has "issues" with the fourth and "highest" of the levels.

Now it seems to me that it is in this fourth - Intellectual/ Spiritual/ Emotional? - level that the guerrilla warfare is being fought out on ET - and, come to that in many other fora.

The second piece of "background" is personal.

About a dozen years ago - when I was just finishing my stint as a "top dog" in a global futures exchange - my ex went to see "Mary Rose", a psychic/ tarot reader who had been recommended to her by a friend. After this, she pestered me on and off for 6 months or so to go and see her, while I poo-poo'ed the whole thing as a good (well, pretty useless, actually) applied mathematician should.

In the end, I was prevailed upon to do so, just to shut my ex up on the subject, and duly caught the train down to Greenwich. I was surprised that "Mary Rose" appeared quite normal, and after introducing myself, she took a tarot pack and started off on a "reading".

Now, at this remove, I cannot remember all of the reading but a few examples of things she said stay with me:

She referred to places, and to names. She saw "Holland" for instance - was that relevant? Yes, I said, I had just that afternoon booked a flight to see an exchange CEO in Amsterdam (which my ex did not know, and would not have interested her if she had). You'll get what you want there, she said, and I did.

She saw "Robert", who was recently dead, and "Canada". A friend of mine, Bob Purves, formerly of the Winnipeg Exchange (whom my ex did not know and had never met) had very recently died. She said that he was a (Taurean? I think). I had no idea, but when I checked, he was.

She asked if I had a car. Yes. Be careful with the steering and brakes she said.

Within a week my ex had parked the car in our drive, which was at 90 degrees off a steep hill, but left off the brake, and failed to straighten up the steering. The car duly trundled off down the hill and caused a few hundred quids worth of damage...

There were other instances, but the long and short of it is that since meeting "Mary Rose", whom I returned to a few times over the years, I have been convinced that there is another level of "consciousness" or maybe "awareness" in which some people have an ability.

This is of course not susceptible to any sort of "proof" and I don't think it is to be relied upon to the exclusion of more "rational" decision making.

The point of all this is that whatever the "truth" is of our "reality" we have to approach it on the basis of our own experience, and, moreover, IMHO on the basis that the "Either/Or" scalpel of Reason is a deeply imperfect way of approaching whatever it is that is "out there".

A Northern Rock Partnership

The "conventional wisdom" is that there are only two options for Northern Rock: "Public" - through nationalisation and State ownership; and "Private" through continuation as a Public Limited Liability Company backed by possibly unlimited "tax-payers' money".

In fact, there is another way - a new synthesis of Public and Private - in which Northern Rock could be restructured, and for which all of the elements are already in place and which requires neither legislation nor a single penny of "tax-payers' money".

The enabler of this solution is that simple but infinitely flexible new corporate body - the Limited Liability Partnership" ("LLP") now coming into use throughout the commercial and public sectors in ways never envisaged in April 2001 when the LLP was introduced to limit the liability of professional partnerships.

Examples include: City of Glasgow (twice); Standard Life's private equity operation, "SLIPE"; Scottish Widows; First Hydro and an innovative LLP involving the Hilton group.

Introducing the Capital Partnership
A Capital Partnership LLP is not an "Organisation" but a framework within which "stakeholder" Members "self organise".

A Custodian owns the assets of the enterprise as a "steward" or "trustee" and may also have certain governance powers as a guardian of the purpose - or "Aims" - which the enterprise was incorporated to achieve.

An Investor or Capital member introduces money or "money's worth" of (say) land, buildings, intellectual property.

A Developer/ Operator Member uses the Capital to achieve the purpose of the enterprise, and shares the revenues with the Investor in agreed proportional "units" or "Equity Shares". e.g. millionth's or billionth's.

A Northern Rock Partnership could be structured as follows.

Custodian
Firstly: the Northern Rock Foundation already owns 15% of Northern Rock Plc, and receives 5% of profits which it has historically applied, extremely successfully, to good causes.

Secondly; as has been recently documented in the Press, the Northern Rock "Granite" vehicle is an exemplar of the SIV's which have been constructed throughout the UK mortgage industry to allow securitisation of mortgage loans and involve technical "ownership" of assets by charities which are typically not even aware of the staggering scale of assets and liabilities nominally held in their names.

Shareholders would transfer their shares to the Northern Rock Foundation, and would in return become Investor Members - see below. The existing trust arrangements for the Granite assets would also be transferred from the Down's Syndrome North East Association (UK) - the unwitting existing beneficiaries - to the Northern Rock Foundation.

Investors
The key Investor is currently the Bank of England, while the Treasury has a minor direct interest through the 1.25% penalty payment being applied to Northern Rock, and which is "rolling up" as a "subordinated loan". The Treasury also has a very large contingent liability, in respect of deposit guarantees.

As Tim Congdon revealed in the FT recently, politicians, press and public alike are under a misapprehension as to the true position.  The money being loaned by the Bank of England has in fact never been anywhere near a tax-payer and is created by the Bank of England by the "stroke of a pen" - or more likely, with a "click of a mouse" - in the same way as it creates bank-notes, also to provide necessary liquidity.

The privilege of money creation gives rise to income known as "Seignorage" and the true position, as pointed out by Tim Congdon, runs entirely contrary to general perception. The 5.5% interest levied by the Bank of England on its loans is in fact pure profit, since the cost to the Bank of England of this credit creation is zero.

So the true position is that the greater the loan, and the longer this goes on, the greater will be the "profit" to the tax payer in terms of seignorage, and of course this "profit" will be available to offset any potential loss to the taxpayer if shareholder funds were insufficient to cover Northern Rock losses.

My proposal, building on a suggestion from Hector Sants of the FSA, is that it is possible for the Treasury to make a virtue out of necessity by routing all "seignorage" payments by Northern Rock to the Northern Rock Custodian member of a Northern Rock Partnership and for the resulting "Pool" of funds to constitute a "Default Fund". Clearly the Treasury/FSA etc would require representation on the board of the Custodian.

After making the necessary provisions into the Default Fund, the balance of Northern Rock net revenues would be divided between the other Investors ie the shareholders and the Developer/Operator which would essentially constitute a "Cooperative" of staff and management not dissimilar to the John Lewis Partnership, and bolstered by new and innovative management.

A New Asset Class?

In Canada there are essentially two Capital Markets: the conventional market in listed Company stocks, and a parallel market in "Income Trusts" consisting of units in the gross revenues of these listed Companies, created using trust law.

It would be straightforward for a market to develop in proportional "units" or "Equity shares" e.g. billionths of gross revenues flowing through a Northern Rock LLP. While for tax reasons this would not be currently practicable for UK pension investors, it would be attractive to overseas investors not least because the structure is to all intents and purposes a "Sukuk" in structure, and Islamically sound at a deep level.

The effect for existing shareholders would be that they would be participating in the revenues of Northern Rock alongside, rather than after, the management and staff - which is the not unattractive proposition which accounts for the popularity of Income Trusts in Canada.

Outcome

In summary, Northern Rock Plc would be gradually "dis-intermediated". Any necessary money not available from Depositors will be created either by the Bank of England, or directly by the Treasury, and a provision (essentially a charge for the use of the government guarantee) - set at a suitable level - would be levied upon Northern Rock and held as a "Default Fund" by a Custodian.

A proportion of the net revenues would be shared between the existing shareholders - now as Investor members of the Capital Partnership - and the management and staff, thereby aligning their interests. Any excess from the Pool/ Default Fund could be available for public purposes, such as investment in affordable housing.