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Westlake Legal Group > Posts tagged "financial crisis"

David Green: How a new corporate structure can get Britain back on track after Covid-19

David Green is Chief Executive of Civitas.

After the economic downturn of 2008, it took five years to get back to pre-recession GDP. The Coronavirus crisis is likely to produce a much sharper drop in output and the Government needs to be thinking actively about how best to encourage a resurgence of enterprise.

Its first thought will be to cut corporation tax and short-circuit a few regulations that impede enterprise. But there is a risk that such measures will not produce the well-paid employment throughout the land that the Government wants.

If we look around the economic landscape, not all economic activity leads to the output of goods and services, and the provision of well-paid jobs. Two activities have drawn criticism, not only from those who dislike markets as such, but also from the strongest supporters of markets.

The first is tax avoidance. The OECD has been concerned for several years by the growing tendency of international companies to reduce their tax liability by using sophisticated accounting devices. Its ‘base erosion and profit shifting’ (BEPS) project has tried to reduce the problem, so far with only modest success.

The second is business activity that is extractive rather than productive. For instance, the buying and selling of commodities, currencies, or shares for the sole purpose of making money from the transaction can hardly be called productive. It would not be feasible to prevent such arbitrage but there is no reason to treat it in the same way as enterprise that adds value by producing goods and services.

One approach would be to create a new legal framework for companies that would more effectively harness self-interest to service of the public good.

For most of the post-war period American companies have been able to register with the tax authorities as a ‘C’ corporation or an ‘S’ corporation. A ‘C’ corporation pays corporation tax, but an ‘S’ corporation does not. All profits and losses ‘pass through’ to the shareholders who must not exceed 100. If shareholders take profits in the form of dividends then ordinary income tax is due. This provides an incentive to keep profits invested in the company.

Our Government could adapt this model for the UK by creating a new corporate structure – an enterprise company. Such companies would be required to have their headquarters in the UK and would not be liable for corporation tax – so long as profits were retained in the business as reserves or reinvested in the production of goods and services.

Without corporation tax there would be no need for separate taxing of capital investment via the capital-allowances regime. Investment in plant and machinery would a business expense like any other. However, enterprise companies should still be eligible for research and development tax credits. Profits could only be distributed as dividends, in which case recipients would be liable for income tax as individuals. The use of tax havens would be prohibited and companies must be involved in producing goods and services.

Furthermore, no organisation that bought and sold shares, commodities, currencies, property, or derivatives merely to make money from the transaction would be eligible. Shareholders must all be individuals. No other corporation could hold shares in an enterprise company, which would severely reduce mergers and acquisitions revealed by numerous economic studies to be destructive of value.

Finally, as Hayek proposed, all shareholders should have an annual opportunity to decide whether their personal share of the profit is ploughed back or taken as income. This would not be a majority decision. It would be a personal choice exercised by each shareholder.

Knowing that they could take their share of the profits out once per year would have two effects. It would encourage individuals to invest, and it would incentivise executives to come up with better ideas for investment than buying back the company’s own shares or increasing their own remuneration.

HM Treasury will have to forgo some of the £50 billion raised in corporation tax, but with this new kind of corporate structure we can anticipate the emancipation of a new generation of entrepreneurs whose ingenuity and drive is more likely to spread well-paid, tax-paying, jobs throughout the land.

Real Estate, and Personal Injury Lawyers. Contact us at: https://westlakelegal.com 

Garvan Walshe: Why the Government must convert its business Covid-19 support away from debt

Garvan Walshe is a former national and international security policy adviser to the Conservative Party.

The immediate economic cost of the Covid-19 epidemic and the measures needed to contain it are starting to become clear.

Vast government borrowing. Huge numbers of people being paid not to work. The total devastation of the travel industry.

But it is also important to look at the longer-term structural effects of the disease and the measures taken against it.

These will determine the shape of the global economy for the decades to come.

The financial crisis twelve years ago has created a world of ultra-cheap money, inflated asset prices, and in the UK, an austerity programme whose effects have been felt by the young immediately, but which have had knock-on effects most visible in continuing weak productivity growth.

The rate of productivity growth is what’s known mathematically as second derivative. It is related not to the level of economic output, nor to the rate it changes (that is, growth), but to rate of change in the rate of change of output.

It is the economic equivalent of R0, the rate at which one person infected by the coronavirus infects another. It feeds though to growth, and on to the level of output.

The way countries cope with the economic effects of the epidemic will have profound effects on productivity.

Among the most important is not actually the evolution of global supply chains, which will recover from this shock and were reconfiguring anyway, or personal habits (once the shock has worn off people will want to see friends, go to conferences and explore the world as much as they ever did), but in the financing of companies.

Just as the wrong post-financial crisis policies saddled some economies with high debt-servicing costs, the wrong Coronavirus support policies will do the same for companies, and smother the creativity on which economic growth depends.

In normal economic circumstances, debt concentrates the mind.

The need to pay it back is supposed to act as a deterrent to borrowing too much, and the need to have it paid back is supposed to prevent reckless lending.

Companies that take on more debt than their revenues allow eventually go bust in the “destruction” part of creative destruction.

The important thing though is that companies’ fortunes are supposed to be contingent upon their own actions: the good ones survive and the bad ones don’t.

But Covid-19 is a global, external shock from outside the economic system. Whether your business is affected by it has a lot more to do with what overall sector it is in, than the quality of its operations.

Certain sectors where the UK is particularly strong, including high value person-to-person services like education, media production and sport have been especially hard hit by the virus.

The music industry, another area of British strength, has been pummelled.

These do not employ huge numbers of people, but they make a lot of money.

At the other end of the labour market, hotels, pubs and restaurants will be devastated.

Though furlough has taken care of their rent bill, and business rates have been drastically reduced, these businesses have ongoing obligations – mainly rent – they still have to pay.

Yet, the Government’s policies to shield businesses from the pandemic have so far chiefly taken the form of providing cash in exchange for creating further ongoing obligations – that is, debt, whether in the form of the Coronavirus Business Interruption Loans, or the Bounceback Loans for micro-businesses.

Debt is suitable for normal times, because it can be used to distinguish between successful companies, and those that need to fail.

But used against an indiscriminate shock like the Coronavirus, it risks becoming a huge weight on the private sector, discouraging innovation and reducing productivity growth even further.

Debt reduces the amount of money a business has available to invest in its own activities.

Repayments must be given priority over research and development, marketing, and even paying staff: it is far easier legally to make someone redundant than default on a debt.

We have a very flexible labour market, which promotes growth and innovation, but debt is an inflexible form of finance that does the reverse.

The usual alternative, equity, won’t quite work in this circumstances.

An equity investor takes a share in the company, and so ties themselves to its fate.

The deal is that if the company doesn’t make any profits, your share is worth nothing. The upside, of course, is that the bigger the profits are, the bigger your reward too.

This is perfectly reasonable for a private individual or venture capital fund in normal times, but unsuitable for mass government support for the economy.

Investors take a lot of time to find out about the companies they invest in, not only to work out whether to invest, but to decide how large a stake they should demand in exchange for their capital.

That is a negotiation only possible under normal market conditions.

The whole point of government support is to prevent companies driven to distress having to sell up because of the pandemic.

And anyway, no government bureaucracy is going to be able to make that kind of decision, especially for hundreds of thousands of SMEs that most need support.

Rather than ordinary debt, which will hang around the necks of businesses for years afterwards, or equity, which is impossible to price under the circumstances, the Government should create securities with income-contingent repayment.

That way companies would pay them back in proportion to the dividends they paid out, crucially, but only after they had paid their staff and invested in their own growth.

The Government could even package up these future income streams and sell them on to interested investors.

This will allow British companies to specialise in what they do best, finding what has been missed by the thorough and ponderous corporate processes favoured by German-style capitalism, and exploiting the opportunities available before they can catch up.

As the international trade expert David Henig puts it “the places we do really well are those where the rules aren’t clear.”

Government support for the economy during the coronavirus should set us up for recovery by enabling us to keep doing what we’re good at.

Real Estate, and Personal Injury Lawyers. Contact us at: https://westlakelegal.com 

Jesse Norman: The root of the financial crisis can be traced back directly to Gordon Brown and the Labour Party

Jesse Norman is Conservative candidate for Hereford and South Herefordshire, which he has represented since 2010. He is also Financial Secretary to the Treasury,

This is a time in which public debate is disfigured by noise, abuse, accusation and retort. All the more so in a General Election.

But just occasionally you get a moment of real clarity: a time when you can say “Yes, I get it – I see what happened. I understand.”

Take the financial crisis of 2008, for example. It was a cataclysm, no doubt about that, and the debt it created still burdens our public finances. Little wonder that argument has raged as to what happened and who was responsible.

Was it Gordon Brown’s failure as Chancellor, or the hangover of the Thatcher deregulation of the 1980s? An out-of-control bonus culture, bad management at the banks, failures of regulation and supervision, the rise of collateralised debt obligations and other financial derivatives? All these factors have been blamed.

So what’s the truth? Reader, in reality this is one of those rare moments where real clarity is possible. You only need to know one fact to grasp, at the deepest level, what went wrong.

Take a look at the graph below. It comes from the Vickers Banking Commission of 2011, with data from the Bank of England. Long forgotten, it nevertheless tells a remarkable tale.

Westlake Legal Group Vickers-report-UK-Bank-leverage- Jesse Norman: The root of the financial crisis can be traced back directly to Gordon Brown and the Labour Party Regulation Jesse Norman MP Highlights Gordon Brown Financial Services financial crisis Comment banks

The “leverage ratio” is the relationship between how much a bank borrows and how much shareholder capital it has. Three things immediately stand out:

1. The average ratio for the UK banking sector between 1960 and 2000 was 20x, i.e. as a whole UK banks borrowed twenty times their capital.

2. That ratio of 20x capital was remarkably consistent. It broadly stayed the same over 40 years, including the go-go 1960s, the stagnant 1970s, the energetic 1980s, the NICE or non-inflationary continuously-expanding 1990s.

Don’t forget that in other respects those decades were anything but stable. Among other things, there was a secondary banking crisis, the near-collapse of Barings, Black Wednesday and the UK’s exit from the Exchange Rate Mechanism, a host of foreign sovereign debt crises, and several recessions. But despite all this, UK bank borrowings remained pretty constant, at 20 times capital.

3. However, around the year 2000 something absolutely fundamental happened. After that date UK bank borrowings started rising, and rising fast. In 2004 they exceeded their 40-year peak at 26x capital. By 2006 they were over 30x, and accelerating fast.

In 2008-9 UK bank borrowing peaked at over 50x capital. At that moment, the UK banking sector as a whole had £100 of debt for every £2 of shareholder capital. Some banks had less, some considerably more.

Thus when disaster struck in 2008, it hit a banking sector that was more than two and a half times as leveraged as it had been over nearly 50 years. The effect of this was catastrophic, as the sheer burden of debt pushed the whole sector into meltdown.

The conclusion is inescapable. Indeed, rarely if ever can a historical picture be so clear.

Many specific factors played a part in the banking crisis of 2008. But at root that crisis was the result of gross overleveraging – indeed an orgy of borrowing – by the banks, permitted by a lax regulatory and supervisory regime.

That regime was created by the Labour Party. It was Gordon Brown as Chancellor who decided in 1997 to transfer bank regulation from the Bank of England to the Financial Services Authority, and it was Brown who set the regulatory framework through the Financial Services and Markets Act 2000.

That was the last time Labour was in government. Yet compared to the present Shadow Chancellor, Brown seems a paragon of prudence. Voters, beware.

Real Estate, and Personal Injury Lawyers. Contact us at: https://westlakelegal.com 

Natalie Elphicke: It’s time to break free from the long shadow of the financial crisis

Natalie Elphicke OBE is the Chief Executive of The Housing & Finance Institute.

A decade on from the financial crisis we are still feeling the effects. Growth is too low, our economy still too unbalanced and too often different groups in our society are set against each other in arguing over the slices of a cake that simply hasn’t been growing fast enough. It’s time to break free from the long shadow of the financial crisis. The next Government must seize the opportunities to rebuild the enterprise economy and to forge an aspiration nation.

More than a decade ago the financial world as we knew it went into free-fall. Never in recent decades have the global financial markets been more fragile; have so many individual livelihoods and prosperity hung on a thread. I was working in housing finance at the time, as one of the City’s foremost structured finance lawyers for my specialist area; working on complex transactions amounting to many billions of pounds; managing business-to-business relationships with some of our country’s most important banks.

As the financial crash hit it affected every type of finance: credit lines for small business, development finance, mortgage lending, trade finance, project finance and even government debt itself. That translated into housing market instability, business failures and a scarcity of finance that simply hadn’t been seen since before the ‘big bang’ of the 1980s. Trust in the financial system itself was in jeopardy as people scrambled to remove cash from banks and building societies.

It was truly a global crisis, the financial equivalent of multiple meteor strikes. The impact of the financial crash was severe. It has also been long lasting. The decisions taken in the immediacy of the financial crisis continue to impact on our political environment today, more than a decade on. This is true particularly around access to housing choices, mortgages, savings and passive wealth creation that had become as everyday an expectation as free access to the National Health Service. The continuing impact is also felt in a lack of confidence in the very institutions on which we rely –political as well as financial.

The financial crash in technical terms is extraordinarily complex. However, it is also pretty simple. The international economic dependency on cheaper and cheaper finance had created its very own ‘Ponzi’ scheme: a lending magic roundabout where everyone chased the bottom of the barrel while laying off the worst of their lending decisions on to ‘other people’. Not quite realising that the ‘other people’, when the music stopped, were actually each other and themselves. Under-priced riskier finance had been passed and split from one institution to another and back again. It had contaminated the whole money pool.

The political responses and interventions to the financial crash were extraordinarily complex. Yet they too were also pretty simple: the central banks and political leaders of the main financial centres around the world worked together to intervene to stop the dam breaking. They prevented the very worst that should have been the natural economic consequence: a recession that could have been more severe than the 1930s’ American depression. A seismic global recession that could have reversed the economic gains of decades. That could have put Western industrialised countries back into the dark ages on productivity and growth.

Fortunately, these interventions were successful. Plans forged over pizza, the boardroom and in the offices of the central banks from countries all over the world stabilised the financial system. Deals done, crises seen off and yet more crises averted. Panic managed, institutions restructured, nationalised, bought and sold. Keep calm and carry on.

Yet this action has a financial tail, in other words a cost and consequence that continues beyond the crisis. It has a political tail as well, a political cost and consequence that continues to this day. Shortly after the financial crash a young colleague of mine said at least she would be able to afford a house now, with repossessions expected to spike and house prices projected to fall. That didn’t happen. Several years later she bought a partly owned (shared ownership) property on a new estate. House prices had continued to rise, but her wages and savings didn’t keep pace.

That is the legacy problem that politicians face today. In shoring up the dam, those who had something to lose, mainly didn’t lose. At least nowhere near the numbers or the scale that was expected. While those who didn’t have the same extent of financial assets to lose, primarily the poorer and younger generations, lost their opportunity to gain in the way that immediately preceding generations had been able to. The generation before them was able to build up a stock of wealth, whereas too often this generation has built up a stock of debt.

The decision to maintain the status quo, to plug the dam, wasn’t altruistic. The scale of the projected failure could have all but overwhelmed the country’s housing and social systems. Reviews of previous housing crises demonstrated the social and economic futility and destruction in the system of mass repossession, house price collapse and re-homing/ re-jobbing/ re-schooling. But bad debt is like a poison; it needs to work its way out, to wash through the financial system. The long journey over the last decade has been one intended to purge the system, but to do so through a slower and softer landing rather than a sharp and catastrophic one.

However, the cycle of economic shocks has also traditionally brought economic rejuvenation. Avoiding the worst of the shock has meant that the economic rejuvenation has been more muted than might otherwise have been the case. That is a problem that we are still today grappling with, where large parts of our economy remain subject to economic drift.

It is by no means certain that any economy will naturally revert to significant economic growth. Other major G7 economies, such as Japan, have faced long term ‘flatlining’, little or no growth that has persisted over many years. The UK is not quite Japan. Yet it hasn’t seen the energy or the dynamic growth that is necessary to fight in post-war or post-shock years. Neither has it seen the big political decisions to unequivocally support growth and prosperity for all.

That is the big political challenge of today. What we call the ‘inter-generational’ crisis in other times would be recognised as the equivalent of the post Second World War years or 1970s poor years. But unless we experience a 1980s-style period of dynamic growth, the country will simply continue to argue about how to divide the cake. Pitting free TV licences against free access to university; quarrelling over whether to subsidise home ownership or social rent, when we need both; rationing our help to those in need, when we should be a land of more and plenty. What is needed is a Government unashamedly committed to growth and economic expansion in the post-Brexit era.

The new Prime Minister needs to dream a dream for all of us, and then put in place the political measures to make it a reality. The re-birth of the enterprise economy and the aspiration nation. To commit to growth, prosperity and opportunity for all.

Real Estate, and Personal Injury Lawyers. Contact us at: https://westlakelegal.com