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Martin Wolf edges ever closer to the 'Anglo Disease' concept

by Jerome a Paris Wed Feb 6th, 2008 at 09:12:16 AM EST

In a pretty explicitly titled piece today (Why it is so hard to keep the financial sector caged), Martin Wolf focuses once again on the structural economic problems created by the financial world. His article, which I'll quote briefly below, provides two graphs that support some of the diagnoses we've been making here and labelling 'Anglo disease':

We can note their increasing profitability (whereas the rest of the corporate world is quite stable in that respect), and their growing place in the economy, both in terms of GDP and, more impressively, of overall profits.

The comparison with the windfall profits of the resource sector, based on extraction of wealth, appears increasingly apt.

So what does Martin Wolf say?

First: financial crises cause economic pain:

When will the next financial crisis come? We do not know. Yet of one thing we can be sure: unless we learn from this crisis, another one will put the world economy back on to the rocks in the not too distant future.

Second: the financial world is inherently unstable and unfair:

the banking sector is the recipient of massive explicit and implicit public subsidies: it is largely guaranteed against liquidity risk; many of its liabilities seem to be contingent claims on the state; and central banks create an upward- sloping yield curve whenever banks are decapitalised, thereby offering a direct transfer to any institution able to borrow at the low rate and lend at the higher one.

In addition, banking institutions suffer from massive agency problems - between clients and institutions, shareholders and management and management and other staff. All this is also exacerbated by the difficulty of monitoring the quality of transactions until long after the event.

Third: crises are almost always systemic and politically hard to pre-empt

As William White of the Bank for International Settlement has noted, banks almost always get into trouble together.* The most recent cycle of mad lending, followed by panic and revulsion, is a paradigmatic example.


Yet, as Mr White also notes, the strength of the pressures against taking "away the punchbowl just as the party gets going", in former Fed governor William McChesney's famous phrase, is formidable. In addition to bureaucratic inertia, such action is subject both to unavoidable uncertainty about the dangers of current trends and to resistance from private interests.

Fourth: it's ultimately a political problem

On the one hand, we have a banking sector that has a demonstrated capacity to generate huge crises because of the incentives to take on under-appreciated risks. On the other hand, we lack the will and even the capacity to regulate it.

Fifth: the system is digging its own grave

A financial sector that generates vast rewards for insiders and repeated crises for hundreds of millions of innocent bystanders is, I would argue, politically unacceptable in the long run. Those who want market-led globalisation to prosper will recognise that this is its Achilles heel. Effective action must be taken now, before a still bigger global crisis arrives.

That last argument is very important, as far as I'm concerned: it's the smart liberals (in the economic sense) acknowledging that things have gone too far and that their (neo)liberalism needs to be tuned down. It's probably too little, too late, given that the crisis is basically unavoidable right now, but this will help define the political battleground: how much more regulation will be allowed as the crisis unfolds?

:: ::

Previous "Anglo Disease" content: Earlier work:

Have you considered emailing him some of your essays to see if it strikes a chord ?

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Wed Feb 6th, 2008 at 09:35:17 AM EST
Seems to me that Mr. Wolf is already reading them.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Wed Feb 6th, 2008 at 10:34:26 AM EST
[ Parent ]
Perhaps he's a member?
<looks around suspiciously>

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Wed Feb 6th, 2008 at 10:38:49 AM EST
[ Parent ]

Capitalism searches out the darkest corners of human potential, and mainlines them.
by geezer in Paris (risico at wanadoo(flypoop)fr) on Wed Feb 6th, 2008 at 02:53:43 PM EST
[ Parent ]
With a link to my earlier summary piece from a few days ago.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Feb 6th, 2008 at 01:57:56 PM EST
[ Parent ]
I'm having a problem lately with the term "profit". We have gross profit, net profit and other variations.

The chart above shows profit before depreciation, interest and taxes. This makes no sense to me and throws the meaningfulness of the chart into doubt.

Financial firms don't have much in the way of depreciation (I would think) compared to manufacturing companies. For those companies which do have large material investments depreciation is an important part of how they make investment choices. If it weren't, than governments would not be tinkering with accelerated depreciation and the like all the time.

Similarly, interest is a basic cost of doing business and should be significant for banks and for those industrial firms that need to raise investment capital on a continuing basis. On the other hand, some firms like Microsoft are self financing and this allows them to be quite profitable.

Finally we get to taxes. Taxes are applied on profit, so I don't even know what profit excluding taxes means.

There might be some logic to graphing funds available to return to investors or keep as retained earnings as a measure of economic well being, this would be similar to cash flow.

If financial firms have been more "profitable" than other sectors then why not just say so without using all these fudge factors?

Looking back a year or two from now will these firms have been profitable or just benefiting from a bubble and the charts stopped too soon? No sector can extract excessive earnings forever, either they foster competition (autos over railroads), or they become big and inefficient (IBM), or they foster so much resentment that government is forced to step in (AT&T).

Right now the drug companies are flirting with international controls because of their excessive profits and the resulting misery that their restraint of trade causes. It may be that the financial firms will be the ones put under tighter controls first, however.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Wed Feb 6th, 2008 at 11:42:29 AM EST
is now seen as the more relevant number as to the "real" value creation of the underlying business. The rest is only the sharing out of that value between the stakeholders (equity providers of capital, debt providers of capital and government) and has no influence on its creation.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Feb 6th, 2008 at 01:24:36 PM EST
[ Parent ]
manipulation, as companies shift operating expenses to various capital accounts.

There are whole industries where this is standard practise, media being a good example. It's a good measure, but it has its limitations as well.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Wed Feb 6th, 2008 at 01:32:39 PM EST
[ Parent ]
I understand its popularity, there are lots of financial gimmicks that are popular (CDO's anyone) this doesn't mean the press or the public and to buy into using them.

Saying that a profit excludes interest payments for a bank is like telling GM to exclude the cost of steel.

I'm claiming its a way to show a big number even when a firm is not really doing that well.

A perfect example is the sale today of $3 billion preferred by Wachovia, paying 8% for ten years. Are they really going to be able to make a profit on these funds that will exceed 8% (even with exorbitant credit card charges), or is it a sign that they are in distress? Next year they will show an EBITDA number that omits this charge. What will that indicate about "creation" of profits?

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Wed Feb 6th, 2008 at 03:02:03 PM EST
[ Parent ]
EBITDA is an intermediate figure in a P&L statement. Basically, net operating revenue, or gross (from all income sources) LESS operating expenses. The "cost of steel" would be an expenditure engrossed by that line item of the P&L statement.

Sale of a bond --if I understand you correctly-- is a long term liability, a balance sheet item. Quarterly and annual amounts of interest paid to bondholders would be engrossed in the I of ITDA on the P&L. It's effect is to reduce Wachovia's taxable income. Interest earned increases the taxable income of the corporation. Similarly, DA (and "deferred tax" payments) modify taxable income of the current year. Whatever amount of net income the corporation does not wish to distribute as dividend to shareholders is the true "profit," i.e. retained earnings or surplus flow of funds at tax year end.

And we've read quite a bit about that over the past decade in the form of share buybacks and depressed wages (productivity). It's net effect --"market" inference-- is to raise the value of price per share outstanding.

So EBITDA is not the number by which the "profitability" of the ongoing concern is valued. Anyhow the "market" is more concerned with predicting future (retained) earnings. MSM focus on growth and "profit" from quarter to quarter is, to my mind, an expression of relative disinterest in the fundamental operating structure of a business.

There's more to learn about applicable GAAP, it's true. For this reason alone wise ones always read the footnotes of ARs.

Diversity is the key to economic and political evolution.

by Cat on Wed Feb 6th, 2008 at 06:33:57 PM EST
[ Parent ]
So there's no misunderstanding, proceeds of a bond sale is a debt. It is not income.

Diversity is the key to economic and political evolution.
by Cat on Wed Feb 6th, 2008 at 06:56:00 PM EST
[ Parent ]
Interesting comment that raises some flags but I believe there are reasons for using EBITDA (Earnings before interest, taxes, depreciation and amortization) for comparison purposes:
  1. It allows for comparisons across time and space I.e. since 1940s when the graph starts, interest rates, corporate income taxes, and depreciation accounting have changed dramatically. If they were included then the comparisons would not be equivalent. Same stands for cross-country comparisons
  2. Comparing between financial and non-financial sectors using EBITDA is actually favorable to the non-financial sectors. This is because, as you note, they have to deal with important asset depreciation hence if depreciation was included the graph disparity would have been even wider.

So this representation is not IMHO using fudge factors to achieve a desired effect.

Orthodoxy is not a religion.
by BalkanIdentity (balkanid _ at _ google.com) on Wed Feb 6th, 2008 at 01:36:52 PM EST
[ Parent ]

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