Wednesday, 29 February 2012

TaxCast on Bankers' Bonuses

The Tax Justice Network is publishing monthly 'podcasts' suggesting improvements to the UK's tax system.  I've listened to this month's edition: most of it consists of monologues by Richard Murphy.

One of the subjects Murphy discusses is the taxation of bankers bonuses: is the whole bonus environment properly taxed at this time?  And my answer to that is no, the tax system is far too generous with regard to bonuses at present. Quite a number of these bonuses are now paid in shares.  That also means that quite possibly part of the bonus will now be recognized as capital gains rather than income, and as a consequence it might be taxed at a lower rate...
Yes, a substantial proportion of the larger bonuses is typically paid in deferred shares: a typical structure being that about half the bonus is in shares, and those shares vest in thirds one, two, and three years after being awarded.  The holder is not able to sell the shares until they have vested, and may forfeit them, particularly if he voluntarily leaves his job.  There are various government schemes to encourage share awards, but they do not cover the sort of large awards Murphy is concerned about.  So the tax treatment is simple: the shares are subject to both income tax and national insurance contributions, as described here.  Usually the awarding company meets these obligations by selling the appropriate proportion of the share award on its vesting date.  (The employee has the option to pay at the time of the award: some bankers will have done this two years ago in anticipation of the introduction of the 50% tax rate in April 2010.)  Contrary to what Murphy, a self-proclaimed tax expert claims, none of the bonus is recognized as capital gains.  Capital gains tax applies only to changes in the value of the shares after the time when income tax has been paid, just as it applies to any investment in shares.

Murphy continues:
The second issue is that actually we give an enormous subsidy to pay these bonuses.  When a bank declares that it's going to pay somebody a bonus of, let's call it a million pounds, in the UK they get tax relief on that payment.  This year they'll be getting tax relief of around 26% of that sum, so two hundred and sixty thousand pounds of that bonus of a million is effectively paid by reducing the bank's corporation tax bill.  Well if that's the case then we should be using the tax system to reprice bankers' bonuses and that can be done by simply removing the tax relief on the part of the bonus that we consider excessive.  Now this is a completely valid use of the tax system to deliver a social purpose, to raise money, and to save something which is causing harm to the market - and that's what these bonuses generally are perceived to do - should be priced by the tax system to discourage them.
Here he is quite right about the operation of the tax system.  Staffing costs, whether salaries, benefits, or bonuses, are considered to be operating expenses.  Corporation tax is levied at 26% on profits, which naturally are calculated net of operating costs.  He's also right that we could, if we wished, change the tax system to make large bonuses more expensive to pay, though I suspect the tax would be more effective if implemented as a payroll tax, following Alistair Darling's example two years ago, rather than by means of corporation tax.

But there are two problems with this.  First, if you make it harder for banks to pay bonuses, they will compete for staff by paying higher salaries instead - this happened in 2009.  And bonuses are preferable to salaries in that they give banks control of their staffing costs: they can and do pay less when they make losses or insufficient profits.  Second, the City of London is hugely profitable for the UK - PwC estimates the total tax contribution of the financial sector in 2010 as £53.4bn.  There are good reasons for banks to operate in London, but they're not so overwhelming that there's no level of taxation at which business will tend to shift overseas.  Darling judged correctly that his payroll tax would not do that, but he was careful to say that it would be for one year only (a year later Ed Miliband had forgotten that).  Murphy perceives banking as an evil that should be discouraged by taxation, but alas it is not within the UK government's powers to end the international banking system.  Is Murphy willing to forego many billions of pounds a year in tax revenues simply in order to express his distaste?

Politician behaves inconsistently when offered money shock horror

Here are Chris Huhne and Sayeeda Warsi giving a joint press conference 18 months ago, at which Warsi told former Labour ministers they shouldn't be accepting severance payments, because of their alleged "frankly criminal" irresponsibility in office.  No criminal charges have been forthcoming.

Here is Chris Huhne accepting a severance payment following his resignation from office to face criminal charges of perverting the course of justice.

Monday, 27 February 2012

Fast falls the eventide

A fortnight ago the town of Bideford made its most important contribution to English jurisprudence since its witch trial 330 years ago.  Mr Justice Ouseley found that Bideford Town Council is not allowed by the Local Government Act 1972 to hold prayers as part of its meetings.

The ruling was met by a chorus of ill-informed protest.  Eric Pickles said that councils "should have the right to say prayers before meetings if they wish".  The ruling agrees with him - prayer meetings are permitted before council meetings, but not as part of them.  A spokesman for the Christian Institute called the ruling "extraordinary" on the grounds that the "practice that goes back to the Elizabethan era".  Quite possibly, but then councils in the 16th Century were not bound by the 1972 Act.    The Bishop of Exeter said "I think it's a great pity that a tiny minority are seeking to ban the majority, many of whom find prayers very, very helpful, from continuing with a process in which no-one actually has to participate."  This goes to the heart of the matter.  The idea of democracy is not John Adams' "tyranny of the majority": it should be a system which disempowers oligarchs while respecting minority rights.

Suppose there were a majority on the Manchester City Council in favour of singing songs in support of Manchester City Football Club at the start of council meetings.  Should that be legal?

There is one sentence in the ruling that reads oddly: "18. As the prayers at Bideford Town Council were always Christian, or occasionally Quaker led...".  This seems to imply that Quakers are not Christians.  I think George Fox, William Penn, and my mum would dispute that.

Friday, 24 February 2012

Greek Sovereign CDS

One minor but interesting aspect of the latest Greek bail-out is its effect on Greek government CDS.  When the private-sector write-down was first agreed back in October, it was accepted that it would be voluntary and so would not trigger CDS payouts.  This time, I'm fairly sure that there will be a triggering event, despite the scepticism of some commentators.

There are two reasons why I think so.  First, the Greek government says that it will today introduce legislation to parliament retrospectively to apply "collective-action clauses" for most of its debt (the part governed by Greek law).  This will be necessary to force the quite large minority of its debt-holders which is not susceptible to international government arm-twisting to accept the write-down.  And ISDA, the body responsible for ruling on defaults for CDS purposes, made an unambiguous statement last month about this possibility:
...the inclusion of a CAC would not, in and of itself, be expected to trigger a Credit Event. On the other hand, the use of such a clause to effect a reduction in coupon or principal or one of the other events set out in the definition of the Restructuring Credit Event could trigger if the other requirements of the Restructuring Credit Event were met (for example decline in creditworthiness), as its effect would be to bind all holders of the relevant debt.
Which is to say that if the CAC is implemented and then used to force a write-down, ISDA will declare that CDS payouts have been triggered.  European politicians will be asking them not to, because they've been straining throughout the crisis to avoid anything that could be called a default.  And some American banks and insurers will be doing the same, because they've written the CDS contracts.  But ISDA has stated its position, which is mandated by its own procedures.  Its argument last time round was that a voluntary write-down is not a "restructuring credit event", whereas a write-down that "binds all holders of the 'restructured debt'" would be.  There's no getting out of that logic.

Second, the markets think it's going to happen.  Markets tend to get these things right, because there's a lot of money being staked on the analysis.

How much does this matter?  Well, it would restore some meaning to the sovereign CDS market.  But the direct financial consequences are quite small.  Because every CDS has its own expiry date and swap rate*, if you want to trade out of a CDS position you have to enter into a new contract that roughly offsets the risk.  Net positions are therefore much smaller than gross positions: Table 6 here shows gross notional $69.9bn, net notional $3.2bn (in the "Hellenic Republic" row).  There's a plot here showing the net positions of individual banks: if you're a British taxpayer, and hence have a financial interest in the fortunes of RBS, you'd like the CDS to pay off.

*Exchange-trading of CDS using standardized contracts was introduced in 2009.  But these contracts don't yet dominate the open interest.

Wednesday, 22 February 2012

The latest Greek bail-out

It can't work and it won't work.  There's not much point in my telling you why not, other commentators have done an excellent job already.  This is not because the powers-that-be are acting particularly foolishly; it's because there are no good options available.  Daniel Davies has put together an ingenious game in which you can try in vain to come up with something that works: the current deal leads to paragraph 26.

Quite apart from the numbers not working, a general election in Greece has been promised for April.  Wolfgang SchĂ€uble, the German Finance minister, wanted the elections postponed, because he quite reasonably had no confidence that an incoming government would abide by the terms of a bailout package, but a postponement seems not to be part of the deal.  I suppose there will be an attempt, probably not in public, to get anyone who's at all likely to be important in the next government to sign up to the deal before any money is handed over.  This could break down very quickly.

Wednesday, 15 February 2012

Mathematician thinks mathematicians are very important

Ian Stewart, writing in the Guardian, says that the Black-Scholes equation
opened up a new world of ever more complex investments, blossoming into a gigantic global industry. But when the sub-prime mortgage market turned sour, the darling of the financial markets became the Black Hole equation, sucking money out of the universe in an unending stream.
This is just wrong.  The Black-Scholes formula is used by major players in the derivatives market only as a calibration tool, to obtain "implied volatilities" which give one a measure of how far market option prices diverge from an equation all the players know to be a simplification.  And the pricing models used for the mortgage-backed securities that caused the financial crisis have got very little in common with the Black-Scholes equation.

Stewart is wrong too in what he says about Nassim Taleb's notion of "black swans".  In Taleb's conception a black swan is not just an extreme event, it's an event that couldn't possibly have been built into a model because the modeller couldn't reasonably have even considered the possibility of its happening.

Stewart opens his concluding paragraph by asserting that "Despite its supposed expertise, the financial sector performs no better than random guesswork."  He doesn't explain this remark, but it's not a fault of the financial sector if the Efficient Market Hypothesis is nearly true.

Having established to his own satisfaction that financial mathematics caused the financial crisis, Stewart concludes that what's needed is more, better, financial mathematics.  This isn't exactly wrong - who would be against doing things better?  But I am sceptical that we need mathematical advances before we can design a sufficiently stable financial system.

I have the advantage over Stewart of having done this stuff for a living.  And I say that:
- nothing can make financial markets follow any particular model, unless a tradeable arbitrage exists when the market deviates from the model.  (The Black-Scholes model is based on an arbitrage strategy of sorts, but one that operates only in an idealized world: the arbitrage is not tradeable in the sense I mean).  Therefore financial models are tools for understanding financial risk, not for eliminating it.
- financial mathematicians (quants) don't make ill-advised trades: traders do.  It's the duty of the quant and trader both to make sure that traders understand the limitations of the models.
- from a mathematical viewpoint, the financial crisis occurred because traders grossly underestimated the probability of correlated mortgage defaults.  That's got little to do with black swans - it was foreseeable and foreseen that the US housing market wouldn't go up forever.  And not very much to do with models - even the simplest models for mortgage-backed securities had a correlation input.  It's got a lot to do with the hubris of traders who chose to bet the house on their guesses of an unobservable and unhedgeable parameter, and the failures of understanding of the bankers and insurers who let them do it.

Friday, 10 February 2012

Greek budget numbers

In a comment on my previous post about Greece, Frances Coppola helpfully directs my attention to this spreadsheet put together by Yiannis Mouzakis, using data from monthly reports by the Greek finance ministry.  (The reports give year-to-date data, so the spreadsheet backs out each month's figures by subtraction: it's possible that some months' results are affected by restatements of previous months.)  I've created a similar spreadsheet myself: the primary* balance for January-June is a deficit of €5.7bn, for July-December a surplus of €360mn.  The corresponding numbers in Stephanie Flanders' article  are €5.1bn and €1.4bn.

It's possible that Flanders' numbers include two receipts not part of the main budget figures, listed as "Revenue from financial transactions".  The amounts are €952mn in July and €380mn in December.  I suppose this is income from the sale of assets, such as the sale in June of a 10% stake in OTE Telecom.  Adding these sums in gives a July-December primary surplus of €1.7bn.

This looks like good news for Greece.  However, also not included in the figures are some significant outgoings, including €1.38bn in December for "Acquisition of credit institution's preferred shares"  and a further €306mn in the same month for "participation in the share capital increase of various enterprises".  The total of additional outgoings over the six months is €2.6bn. The purchase of preferred shares is the final stage of a bank bailout scheme set up in 2008, and compensates Greek banks for their write-downs on government debts.

So the summary is that the Greek government did run a primary surplus for the last six months of 2011, if you count all its income and only some of its expenditure.

Does this put Greece in a position where default becomes a relatively attractive option?  No, in that it would create a run on the Greek banks at the same time as inflicting further write-downs on them.  Yes, in that the cuts being demanded of it now seem to be aiming for a substantial primary surplus.  It's hard to see why any Greek politician wanting to be re-elected in April would back the Eurozone's demands - even if they think it the right thing to do they'll be waiting hopefully for someone else to say so.

*"primary" in this context means "not including debt interest payments".  If you have a primary surplus you can consider defaulting, since you don't need new borrowing to keep going.

Wednesday, 8 February 2012

People who disagree with me are stupid

Or perhaps not. They might not have chosen to consider my argument properly, if at all.  Or I might not have expressed myself clearly enough.  Or they might have a different view of the desirability of trade-offs involved.  Or I might be wrong.

However, there is a line of research purporting to show that right-wing ideology (which disagrees with me) is associated with being a bit thick.  A recent paper added to this corpus has been seized upon by George Monbiot in the Guardian  "conservatism thrives on low intelligence and poor information".  I think that's a fair description of Republican politics in the USA currently - the candidates for the Republican presidential nomination have recently been conducting a series of debates of quite extraordinary stupidity.  But in the UK, the Conservative Party, whose policies are well to the left of the intelligent and thoughtful Barack Obama, strikes me as no less intelligent than the Labour Party.  Its problem is a lack of concern for the problems of the economically unfortunate, not any inferiority in policy analysis, nor a reluctance to argue its case coherently. (Tim Worstall makes the case that in the UK 'conservative' and 'Conservative' may not be the same thing.)

The paper itself finds "that lower general intelligence (g) in childhood predicts greater racism in adulthood, and this effect was largely mediated via conservative ideology".  What the authors did is analyse some existing data from two studies in the UK, each of which tested a group of children then years later asked them questions as adults.  From these data they distilled measures of general intelligence g, social conservativism, racism, socio-economic status, and education level.  They then used a factor analysis to show that social conservatism is quite strongly negatively correlated to g, even taking into account socio-economic status and education level.  Another factor analysis including social conservatism as a factor showed that g is not a predictor of racism once you take social conservatism into account.

There are a lot of criticisms that can be made of the statistical methods: William Briggs outlines them here (but his comments about the tiny correlation along what the paper calls path c' are rather unfair: the authors are clear about it).  But the fundamental problem is that this paper is not setting out to test competing hypotheses, it's just looking for confirmation of one idea, by means of a crude measure of social conservatism.  The paper gives examples of the questions used in this statistic: “Give law breakers stiffer sentences”, “Schools should teach children to obey authority”, and “Family life suffers if mum is working fulltime”.  Similarly, the example questions it gives for the racism statistic are "I wouldn't mind working with people from other races” and "I wouldn’t mind if a family of a different race moved next door”.  What the results tell us is that the same people who answer yes to the 'conservatism' questions tend to answer no to the 'racism' questions, and those people tend to have lower g scores.  But those answers are not just conservative (by one definition) and racist, they are also unnuanced.  Perhaps the same people would have agreed also with some other questions on the questionnaire, such as "Ordinary working people do not get their fair share of the nation’s wealth" or "Private schools should be abolished".  If so, a differently motivated analysis might have found that g is negatively correlated with left-wing views, and left-wing views predict racism.

Perhaps a social scientist would care to conduct a statistical analysis to determine whether social scientists tend to seek confirmation of their own prejudices in the way they choose to analyse data.  Or perhaps it would be safer to get someone else to do it.

Mid-Table Obscurity

There's a strange story in the Guardian, with the headline "UK trails Poland and Bulgaria on adults educated to A-level standard" and the subhead "Lecturers' union says European data shows Britain risks languishing in 'mid-table obscurity' due to rising cost of learning".  You don't have to read on to guess that the story is not going to make sense - there are no fees for A-level education at state schools in the UK.

The statistics behind the story are from Eurostat.  The data are described thus:
The indicator shows the percentage of the adult population (25-64 years old) that has completed upper secondary education. The indicator aims to measure the share of the population that is likely to have the minimum necessary qualifications to actively participate in social and economic life. It should be noted that completion of upper secondary education can be achieved in European countries after varying lengths of study, according to different national educational systems.
So it means no more than having attended school or college for two or more years of what in the UK is called the sixth form.

The lecturer's union - the UCU - has its statement in full on its own site.  It is concerned about "the very real possibility that we will slide further down the table as people find it harder to access education following price hikes and restrictions on places."  I can reassure it that university tuition fees will not make it harder for students to complete sixth form studies.

I'd like to read an intelligent discussion about what proportion of the student population could benefit from sixth form studies, how that should be divided between traditional A-levels and vocational qualifications, and what the rest of the 16-18 year-old population should be doing.  We might even learn from a comparison with the rest of Europe.  The Guardian?  Anyone?

Monday, 6 February 2012

The mystery of the primary surplus

Eleven days ago, Stephanie Flanders, economics editor of the BBC, announced that "the Greek government has slashed its way to a primary budget surplus: as of now it is only borrowing money to pay off the debt...look at the Greek government's budget outturns for the second half of 2011, published earlier this month. As Graham Turner of GFC Economics has noted, these show a real step-change in the effort to cut spending and actually collect more Greek taxes...In the second half of 2011...the Greeks seem to have managed a 1.8bn euro primary surplus."

Sundry bloggers picked up on this remarkable turnaround in Greece's budgetary fortunes, noting that it may make a default more likely, in that if you're running a primary deficit you can't afford to default.  And I made a note to look into how Greece had managed it against all expectations.

So I went looking for the data published in January.  And I couldn't find it.  All the mentions of the story I can find online refer to Flanders' article.  It's not mentioned on the GFC Economics site, nor on the associated blog.  So I had a look at the IMF fiscal monitor update, dated two days before Flanders' article.  "headline deficits were larger than expected in Greece owing in part to a weaker economic outturn..." and at its latest (December) country report on Greece " Through end-September, the primary general government balance fell short of the program target by €280 million, or 0.1 percent of GDP". The plan in that document is for a primary surplus starting in Q2 of 2012, revising a previous plan for a primary surplus from Q4 2011.  And here's the IMF country head in Athens last week, insisting that Greece has achieved a lot, but not taking the opportunity to mention a primary surplus.

I see two possibilities.  One is that Greece, having achieved this breakthrough, has chosen to conceal it from the IMF and whisper it only to Graham Turner, who has exploited his scoop not by publishing it but by passing it on to Stephanie Flanders.  And the other is that there has been a misunderstanding somewhere.  I'm keeping an open mind...

Thursday, 2 February 2012


There's an important newish prostate cancer drug called abiraterone which doctors are keen to prescribe to suitable patients.  The drug was approved by the FDA in the USA in April 2011, and in Europe by the EMA in July.  The UK body responsible for approval drugs for use by the NHS, NICE, started its review process in May 2011, intending to conclude its glacially slow deliberations in May 2012. Today it's issued a draft decision that the drug should not be funded by the NHS.

This is not to say that abiraterone is entirely unavailable on the NHS.  The Cancer Drugs Fund was established last year to pay for unapproved drugs, subject to agreement for each patient by the Strategic Health Authority in their region: your chances are better in some regions than others (which is ironic, since the government said the Fund would end the "postcode lottery": I've no idea why they thought they could do that with a regional decision-making process).

There's no question at all that abiraterone is an important advance.  A phase III trial was stopped at the interim stage in September 2010 because the results were too good for it to be ethical to continue with the control group.  The drug works by blocking the body's production of testosterone in a novel way (prostate cancer, until it becomes hormone refractory, needs testosterone to grow), and was found to increase median survival time by 3.9 months in patients with metastatic castration-resistant prostate cancer.

So has NICE got it wrong?  Cancer Research UK, which helped discover the drug (now owned by Johnson & Johnson), has put out a press release saying so.  But really there's no way to tell.  NICE is supposed to consider not just effectiveness but also price in deciding whether to approve a drug: its starting point is the cost per Quality-Adjusted Life Year (QALY), which should not much exceed £30,000 (I haven't found an official statement of the current number), though other considerations can affect this.  We know how good abiraterone is, but we don't know what price Johnson & Johnson have offered it at, so we can't do the calculation.

Which brings us to NICE's real role in all this: it's implementing a pricing mechanism.  The manufacturing cost of producing a drug like abiraterone is trivial compared with the research and development costs, which are usually estimated at something in the region of a billion dollars.  There is therefore a huge gap between the average price the manufacturer needs to charge globally to make a profit, and the price at which the manufacturer is better off striking a deal in any particular market than walking away.  The NHS needs to keep prices down, the manufacture wants to charge the most it can, there's only one buyer and one seller, but there has to be some basis for price setting.  So the semi-public but not clearly defined QALY mechanism allows the manufacturer to calculate a price at which they think the drug will be approved.  The uncertainty has a reason to exist in that it prevents them from pricing the drug right on the limit.  And to reinforce this, there's no negotiation: the manufacturer offers a price and NICE either accepts it or rejects it.

But the mechanism works only if NICE does actually decline to approve some drugs, otherwise prices for new drugs would drift up.  So it has to apply its methods rigorously.  Meanwhile, the Cancer Drugs Fund has reduced the pressure on manufacturers to quote a price that will be accepted, because they know that they will get some sales even at a higher price.  Hence the failure of the market to clear in this case.

So why has NICE announced a preliminary decision to withhold approval?  It must be to give Johnson & Johnson the chance to make its offer more attractive.  Probably not by anything as crude as cutting the price, but by some mechanism such as providing the drug free to any patient remaining on it beyond a specified length of time.  In part this is because some other countries are willing to pay the official NHS price but no more, so Johnson & Johnson will want to keep the headline price high.

At this point I stop on reflect on the absurdity of the whole thing: humanity has created a system for funding drug development that prevents us giving drugs that are cheap to produce to patients who need them, even in one of the world's wealthier countries which is willing and able to pay something like its share of development costs.

The government has radical plans to change this price-setting process.  When I've read the details I'll comment on how they might work.

Take away that fool's bauble

In 2004, Fred Goodwin, then Group Chief Executive of RBS, was awarded a knighthood for "Services to Banking".  On Tuesday it was announced by the Cabinet Office that Goodwin's knighthood is to be "cancelled and annulled", following a recommendation by the Honours Forfeiture Committee.

I would have thought this would be no great loss to him: he should find it easier to enjoy his considerable wealth as the relatively obscure Mr Goodwin.  But his friends and sympathizers are outraged: Alistair Darling, who was a better Chancellor than Gordon Brown, wrote in the Times that "There is something tawdry about the government directing its fire at Fred Goodwin alone..."  Jackie Stewart says that "No single person or even any single bank created the biggest financial recession in modern times...To have this stripped I think is poor for the constitution and very dangerous for the future."  Simon Walker for the Institute of Directors says "To do it because... you don't approve of someone, you think they have done things that are wrong but actually there is no criminality... is inappropriate and politicises the whole honours system".  Digby Jones doesn't disagree with the decision, but remarks it's surrounded by "a faint whiff of the lynch mob on the village green".

What a load of tosh.  Goodwin was given the knighthood for services to banking, presumably because a grateful nation appreciated the contribution therefrom to the economy in general.  We now know that his banking efforts have cost us many billions of pounds - the price of the bailout depends on what the government gets when it eventually sells its shares in RBS, but currently we're looking at a loss of over £20bn.  Against that you can set the tax revenues it's received over the years as a result of RBS's activities, but the end result is not going to be any great gratitude.  Goodwin's services to banking were less than worthless, it was a horrible mistake to give him the knighthood, and now we've put that right.

Goodwin's not the only one whose knighthood was an obvious error?  Then let's unknight the others too.  No single person created the recession?  Quite true: no single person created the profits at RBS either, but only Goodwin got the knighthood.  The annulment politicises the system?  Very funny: it's awards that are decided by politicians, not annulments.  The whiff of the lynch mob?  That's an odd description of the Head of the Home Civil Service and his colleagues.

The underlying argument seems to be that the annulment of a knighthood is a punishment for wrongdoing, to be decided only after due judicial process.  That's wrong.  No one has the right to a knighthood; it's a privilege awarded to about one millionth of the population each year.  Goodwin doesn't deserve this special privilege, and now he hasn't got it, just like millions of others far less undeserving.

I've not attached titles to anyone's name in this piece, apart from Mr Goodwin's.  The things are so ephemeral nowadays.