Lloyds Rights Issue: A Reason to Buy?

I’m rather surprised by the number of hits I’m still getting on a previous post, which noted the unnecessary complexity of the upcoming Lloyds rights issue and the way it’s been presented. I rather thought the weekend papers would clear the matter up, so was unsurprised to read the Guardian Money front page headline “Buddy, can you spare me £13.5bn?”. I immediately followed the injunction “>>Pages 4-5″ and fast-forwarded to read Jill Treanor’s examination of the “implications for small shareholders” and Patrick Collinson’s suggested “plan of action”.

I have to say I was rather disappointed.

Collinson suggests that:

“You got some Halifax shares when it floated. Now we at Lloyds want you to cough up a couple of hundred quid (we won’t tell you the exact sum till later)…”

[my stress]

Treanor also sheds considerable darkness on the point.

Now it simply isn’t true that Lloyds haven’t advised the exact sum investors will have to “cough up” (though they could have been clearer). As I pointed out last time, it’s quite simple: Lloyds wants £13.5bn, which will be divided equally amongst the ~27bn shares in circulation. That’s ~50p a share. If you own 1000 shares you’re going to be asked to put in £500. How many new shares you’ll get and at what price each is yet to be determined.

This is actually a step forward in the organisation of rights issues. The problem is that when a company announces it is going to sell a lot of shares, the price tends to fall – supply and demand – since not every share owner will be able to and want to put more cash into Lloyds equity. By delaying the announcement of the price of the new shares until the last minute, Lloyds has somewhat reduced the risk of the share price falling below the rights issue price, which would be a disaster, since, if you could just buy shares in the market for a lower price, there would be no point taking up the rights issue. The under-writers would end up with all the new shares.

What worries me most about Collinson’s comment piece and Treanor’s Q&A is that they omit part of the case for participating in the rights issue. What I’m about to say should not be construed as financial advice, but there are obvious reasons why a company’s share price might be depressed ahead of a rights issue and that in general a rights issue may be a good opportunity to invest.

The key point is supply and demand for the shares, that is, precisely what Lloyds is worrying about and the reason for the confusion about the offer price for the new shares. Many investors – funds or individuals – may simply be unable to put more money into Lloyds shares. They may just not have the cash. Or, especially if they’re a fund, they may not want Lloyds shares to rise as a proportion of their portfolio. This could even be against the rules of the fund.

Of course, some investors, such as index tracker funds, may be compelled to increase their holding in Lloyds in line with the increase in volume of its equity. But it’s difficult to think of a fund that would be compelled to take up more than its share of rights.

Therefore, it’s often argued, a rights issue is a good time to buy, because there is a surplus of sellers of the stock.

As Jill Treanor points out, you can sell some or all of your rights in the market, for example, to raise enough cash to take up the rest of your rights, a practice known as “tail-swallowing”. Such selling activity will tend to make the rights cheaper. But it’s important to understand that if the price of the rights falls, then so does the price of the existing shares. The reason is the (arbitrage) opportunity to simply sell shares and buy the rights.

Example: To simplify a little, say Lloyds shares fall to 60p when rights have been given to all the shareholders. The rights might entitle you to buy new Lloyds shares for 40p each (so you’d get 5 for every 4 shares you held at the qualifying date for the rights issue) so should sell for about 20p each (since once you’d put in the 40p you’d receive a new share exactly equivalent to the existing shares). If so many people sell their rights that the price is not 20p but drops to (say) 18p, then someone could sell shares for 60p, buy rights for 18p, subscribe to the issue for 40p and make (60 – 18 – 40)p = 2p a share. Do this for a few million shares and you’re building up a tasty bonus pot! What happens when people sell the shares to buy the rights, of course, is that the share price tends to fall until the price of the shares and the price of the rights are aligned again.

So, according to this argument, it may be a good time to buy Lloyds shares, e.g. by subscribing to the rights issue.

It might also be worth noting that Lloyds stated that it will not pay a dividend for 2 years. This may be another reason why some investors (income funds) will not want to hold the shares, though they may already have sold their holdings in the stock.

Of course, there are many reasons why it could turn out to be a bad time to buy Lloyds. They might screw up. Or we might experience the dreaded double-dip recession. And if so many people decide it’s a good time to buy Lloyds, this will push up the price and make it a bad time to buy! Though it is the largest rights issue in the UK to date…

At the end of the day, investors must make up their own minds, and, as I say, I’m not providing financial advice. Patrick Collinson (or his editors) are bold enough to allow themselves a headline “Lloyds looking unattractive” (or “Lloyds rights issue looks distinctly unattractive” in the online version). I just feel investors might also want to take into account the argument that rights issues can be a good time to invest.

Disclaimer: I worked for Lloyds in the early 1990s and own some Lloyds shares.

Why US & China, and not Europe, will Enjoy the Green Technology Bonanza

I’m still reading “Carbonomics” and, whilst mulling over some of Stoft’s (plot spoiler alert) somewhat unconvincing arguments for a carbon “untax” (actually it’s just a regular tax, the un- is an attempt to circumvent the public perception problem), I’ve had a rather nasty thought.

The question is, do aggressive policies of high fossil fuel prices and/or high green energy subsidies or passive policies of low fossil fuel prices and/or low green energy subsidies most favour the development of renewable energy technologies? My argument assumes that in Europe, fossil fuels will be kept expensive due to taxes, carbon trading and so on and renewable energy will be heavily subsidised, whereas in US (& China etc) fossil fuels will remain cheap and there will be limited subsidies.

Obviously my assumption is an over-simplification. In particular, there are sectoral differences, with transport fuels particularly expensive in Europe. But I’m trying to develop a general argument here, so bear with me.

Now, high fuel prices (and renewable subsidies) will encourage the early development of alternatives. So we see, for example, early leaders in solar appearing in Germany and wind in Denmark. Risk-free profits are a wonderful incentive!

But what market conditions will encourage the large-scale roll-out of renewable energy technologies? Well, it’s competition that eliminates the least efficient and forces the survivors to up their game. And, I suggest, competition is going to be most intense where energy prices are lowest and subsidies the most difficult to obtain.

Consider. If, say, two wind power technology players start out and are successful in selling in their home markets, the US and Germany, which will most easily penetrate the other’s market?

The US company will definitely be able to sell in the tough conditions for renewable technology in the US. The German company, on the other hand, has demonstrated only that it can sell in the easier German market with a higher cost of carbon and feed-in tariffs.

Obviously each case is different, and lots of other factors come into play (I’ve assumed that subsidies and fuel prices are higher in Germany than in US, which may not be the case for every renewable technology), but the company accustomed to easy sales is, in general, going to find it much more difficult to compete than the company that has had to fight harder.

The argument is related to the first-mover problem. It may not always be the case that the first company in a market ends up dominating it.

This is all rather awkward, don’t you think?

What it suggests to me is that the best policy at a national level must be not to tax fossil-fuels, nor to subsidise renewable technologies, but to limit fossil-fuel consumption and encourage renewable energy generation other than by price.

The best policy globally is to progressively reduce total use of fossil-fuels, thereby ensuring a level playing-field.

At the moment, no global policy is in place. It’s every country for itself, though there are rewards for reducing fossil-fuel dependency:
- greater energy security;
- a stronger position when a global deal is finally done, as it must eventually be if we’re not all to fry;
- the long-term economic advantage of lower cost – maximised if energy is produced most cost-effectively;
- the potential to export technology (and even energy, e.g. in the form of electricity), similarly maximised when the technology developed is most efficient.

For a country that wants to switch to home-grown renewable energy, policies that make sense therefore include:
- a progressively tighter limit on carbon emissions, implying internal emission trading;
- mandating the use of increasing proportions of renewable energy;
- removing obstacles (e.g. dysfunctional planning processes) to the production of renewable energy;
- a level playing-field for the various renewable energy technologies.

Policies that don’t make sense are those that support over-priced renewable energy:
- carbon taxes (where these price fossil-fuels more highly than necessary to achieve the desired rate of renewable energy uptake);
- feed-in tariffs, that provide guaranteed profit for renewable energy production, regardless of whether or not it is more expensive than other available technologies. Paying ~35p/kWh for electricity generated by solar PV on UK roofs, which I understand may well happen, must be one of the worst renewable energy policies that could possibly be devised.

Of course, whether you use taxes or emission limits supported by carbon-trading, there’s still the risk that if you try to go too fast you’ll spend a lot of money on renewable energy technologies that later turn out to have been very poor value for money. Another reason for insisting on global policies.

In my simplified world, renewable technologies that can survive without subsidies or inflated fossil-fuel prices are the ones that are ultimately going to dominate. Maybe this favours US and Chinese companies, even though Europe is adopting the most aggressive emission-reduction policies. Isn’t economics unfair?

The Great Carry Trade III: Nouriel Roubini Frets about US and a bit on Japan

When I used to frequent the Internet Chess Club they’d often use a message something like: “A hush descends as Grandmaster So-and-so enters the room.” Well, I feel the same reaction should greet Professor Nouriel Roubini’s entry into the discussion of the Great Carry Trade. It’s worth hanging on the Professor’s every word…

Roubini notes that:

“…while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronised rally. While asset prices were falling sharply in 2008, when the dollar was rallying, they have recovered sharply since March while the dollar is tanking. Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades…”

Roubini, characteristically, worries most about the unwinding of the dollar carry trade.

I don’t know, I think there is a wrinkle here, which is that the US dollar can’t actually depreciate, not fully, anyway, because of China’s dollar peg. Therefore it hasn’t got so far to snap back in a panic. Sure, there can be some unwinding if the market suddenly perceives emerging markets to have become overvalued, more risky or growth less certain. This damping of the dollar’s movement makes dollar-funded carry trades less risky than they would be otherwise. This is not good, because it will allow bubbles to inflate even more than would otherwise be the case.

Roubini writes as if carry trading investors are making a currency gain by borrowing dollars, over and above emerging currency and other market movements. That’s only true if your accounting currency is neither dollars, nor, say, sterling, which is hardly appreciating nor going to appreciate against the dollar (and also appears to meet the criteria for a carry-trade funding currency). In fact, it’s only really true if your investors want euros or possibly yen at the end of the day, though one wonders why they don’t just borrow in those currencies to reduce the risk, if they believe a flight to safety would favour the dollar.

Since the dollar’s decline is primarily taking place against the euro, it follows, incidentally, that as I argued last time, the next phase of the game will be characterised by a eurozone trade deficit as well as a US and (not that it’s very significant to the rest of the world) a UK one.

Martin Wolf worries – to a very deferential Tech Ticker audience – that eventual US rate rises will have a dramatic effect. Sure. But – since interest rates do most of their work in curbing inflation through their effect on the foreign exchange rate – that simply means they won’t have to rise very much, doesn’t it? Of course, this will help to fuel further borrowing in US…

It might be worth comparing the dollar carry trade to the yen carry trade. The crucial difference is that the yen carry trade was/is inherently risky, because the yen has, for decades, been undervalued, given Japan’s persistent trade surplus (increasing again in 2009).

But we are in a fairly unusual situation of a reserve currency doomed to eventual decline: we can borrow cheaply in dollars because of its reserve status, but, as its status as a reserve currency diminishes, it will be seen to be fundamentally overvalued because of its trade position and the vast overhang of dollars already in foreign hands. So borrowing in dollars is something of a one-way bet – you don’t have to worry that your fortune has the Ponzi quality of depending on everyone else continuing to want to borrow in dollars. The dollar isn’t going to snap back up – notwithstanding a temporary recovery during the next major crisis – because its value is already being held up by central banks wanting to buy them. Rather, the dollar’s value can be expected to decline over time as it is replaced (by a mix) as the world’s reserve currency. Compared to the yen carry trade the dollar carry trade is a bargain, risk-wise. No wonder emerging market equities are breaking records!

Ambrose Evans-Pritchard is always an entertaining read. He writes today that the next crisis could be a Japanese default. But Japan’s trade surplus must make this unlikely. All they’ve got to do is divert some of Japan’s private savings to the public purse. Maybe a little easier said than done, of course, but there’s still plenty of scope. Of course, if they let their national debt rise from 2 to say 3 times GDP, it could start to get tricky to service…

Meanwhile, Peter Tasker worries about an asset bubble bursting in China. This seems closer to the mark. He compares China to Japan and notes that:

“If China continues to follow the Japanese template, the end of the dollar peg will be the trigger event [for the "final manic stage" of the bubble], setting off a Godzilla-sized credit binge.”

There also seem to me to be similarities with the Great Crash of 1929. We are in a fairly unusual situation of a reserve currency doomed to eventual decline, but it is not a unique situation. Didn’t the UK coming off the gold standard in 1925 convince investors that the dollar was the place to be? Blaming Churchill (who took the decision) is wrong-headed. The problem was that the peg existed in the first place, not that we came off it. It might be hitting the ground that does the damage, but the problem is trying to float in the air in the first place.

It seems to me the sooner China appreciates its currency the less painful it will be for everyone. Especially as, the longer Chinese economic growth exceeds that elsewhere, the bigger the relative size of its economy and the greater the imbalance caused by the undervaluation of its currency against the dollar. As I said when I started trying to get my head round all this, currency pegs are a very bad idea indeed. You may be able to market the buck, but you can’t buck the market.

“Carbonomics” Critique, Part 1

I began reading “Carbonomics” by Steven Stoft late yesterday. I’m only just starting Chapter 3 (of 31) but I can already reach a conclusion.

My very first impression was that “Carbonomics” brings some logical thinking to the debate. I see no reason to change my view: there is no doubt a lot of good material in the book.

But within minutes I could see that Stoft’s overall prescription, sadly, is in dreamland.

I’m posting my initial thoughts immediately whilst I am still in a state of shock.

The history of thought is littered with discarded, but complex and sophisticated, bodies of knowledge, from scientific theories – the Ptolemaic universe perhaps, to political programmes – communism, for example; indeed more than bodies of knowledge, entire institutions, even civilisations, all built on foundations that later proved to be constructed of no more than intellectual straw.

Some of the foundations of “Carbonomics” consist of no more than straw.

I am indeed stunned. I started reading and first came across some encouraging comments in the Preface (a chapter which should never be skipped). The author notes the inefficiency of current policies to improve energy security and global warming and promises to “fix energy policy”. He will be guided by the story of physics, and produce Mr Tompkins in Wonderland for economics. “The hardest part of learning new ideas is giving up misconceptions”, he writes.

I must admit that by this point I was already starting to feel a little uneasy. I don’t, for example, believe that “physicists have a tradition of explaining advanced ideas to the public just because they find the concepts fascinating.” No, they do it to try to prove how clever they are (except for a small number who simply have Asperger’s syndrome). And, given that their belief system doesn’t hang together (relativity and quantum physics are as yet unreconciled) they hope that the more positive feedback – or pats on the back – they can extract from their audience, the truer what they have told them will become. Stoft notes that Einstein “found the uncertainty of quantum mechanics… so disconcerting that he never accepted it”. Quite right. Einstein was a holistic thinker. That was his genius. All the facts had to be taken into account, however alien a theory eventually resulted. He understood that all may not be as it seems, but he could not accept contradictions into his world view, even if others could live with them. So in asserting that “God does not play dice”, Einstein was not being a stick in the mud, but demonstrating he was on the side of the good guys. Even if he didn’t have the whole answer, at least he knew there was a question.

I labour the point because it soon became apparent that Stoft’s thinking is not sufficiently rigorous. He is not prepared to accept inconvenient truths.

It’s a shame, because Stoft starts so well with an excellent account of the effects of the 1970s oil price spike. When the Great Depression is so often mentioned as the worst of economic times, I often feel that the discourse is US-centric – cultural domination perhaps. For the 1970s was as decisive for modern Britain as the 1930s was across the Pond. Inflation and unemployment, a pervasive sense of decline tinged with incipient anarchy. The Punk Era, swept away by the Thatcher Revolution.

Never mind, my point is that Stoft’s prescription will fail. Reading his first chapter I assumed Stoft would urge measures to keep the oil price high. But it suddenly dawned on me that his prescription is the precise opposite!

There’s a why Stoft is wrong, which owes something, I feel, to a US-centric world view.

And then there’s the how Stoft is wrong. I’m afraid to say he has not followed his own prescription in the last line of his Preface, to “pay close attention to the way governments and markets really work”.

Stoft, it seems, still bears grudges against OPEC. On page 4 he explains how he wants to avoid “paying OPEC another trillion dollars in tribute”. He writes of how, by 1986 “OPEC had been crippled”. On p.5 he notes how he will explain “how to crush OPEC again”. On page 6 he reminds us that “conservation… crushed OPEC in the early 1980s”. There’s a bit of a lull while he advocates a “consumers’ cartel” to counter OPEC and worries about how to deal with “free rides”…

Powerful stuff. Where have I heard this sort of thing before? Oh, yes, I remember now – it’s eerily reminiscent of Russia railing against NATO. Yes, that’s right, Russia’s demon is a mutual-defence pact. To many in Russia (unfortunately many of those in positions of power), the idea of Ukraine or Georgia joining NATO – to ensure, as sovereign nations, their own defence – is little short of an invasion of the Motherland itself. I wonder, I just wonder, if OPEC members feel the same way. Let’s just step into Wonderland for a moment. Maybe they feel they have a right to the riches under the desert (or wherever). I know, I know, I’m of the view that oil wealth is a fortunate (or often not so fortunate) windfall. But the actual state of affairs is what we have to deal with – and de facto those countries endowed with generous fossil-fuel reserves are determined to maximise the value of those reserves.

In solving the problem of global warming (and energy security) we have to deal with the world as it is, not how we would like it to be.

Maybe I can lay down something of a more specific principle here. Short of war, there will only be progress in international negotiations if win-win situations are created. Sorry about the cliche. Maybe I can get rid of it. Because, actually, we’re in a multilateral situation and we need win-win-win… in fact a win superscript n, win raised to the power of the number of interest groups.

Stoft is writing from the US. Let’s put to one side that he hasn’t even convinced his own country’s body politic to take the problem seriously yet, let alone of his particular approach. Let’s pretend he manages to do that. Even if that were to happen, I’ve got news for him. The world out there is not full of buddies who will be happy to participate in a “consumers’ cartel”. In fact, it may be unfair only to Canada & Australia to say that the US has only one reliable sidekick with any clout at all on the world stage. Yeap. Be nice to the UK. OK, I’m being facetious – there is some alignment of national interests, at least with the EU and Japan. But the problem is that several populous developing countries show no clear sign of wanting to play ball.

I feel I’ve written moreorless enough for a first reaction, so it’s fortunate that how Stoft is wrong has already been touched on in previous episodes of Uncharted Territory.

The general problem is the Displacement Fallacy, though I appreciate that Stoft intends to avoid this through international agreements, starting with China. Good luck, mate, but I don’t think you’ll manage it.

Reflections on Oil supplemented by Reflections on Reflections on Oil considers how the oil market will react to attempts to choke off demand. The important point is that the oil producers themselves will act as buyers of last resort.

Before I sign off I should mention that Stoft’s discussion of a tax on fossil-fuel and an “untax” (general distribution of the tax revenues) will not work as he seems to expect for imported products. Stoft is clearly unaware of the Man in the Wardrobe fallacy. Oil at $80 + $20 tax (Stoft’s example in ch.2, on p.21) will not have the same outcome as oil at $100. In the first case, the importing country still has $20 to spend, perhaps on more oil imports or perhaps on other goods, the sellers of which can themselves then afford to import more oil.

I haven’t read enough yet to determine whether Stoft is aware of the rebound effect or Jevons’ Paradox, whereby using a resource more efficiently can actually increase consumption in the long term. The signs aren’t good, though.

Although I’m disappointed with Stoft’s overall vision, I will read on, because large parts of Stoft’s analysis are sound. The first part of chapter 2 shows, for example, how cheap it would be to move away from reliance on fossil fuels.

Watch this space.

—–
As an unreferenced endnote, I admit hypersensitivity to inaccuracies or ambiguities and two have been particularly irritating:
- in Ch.2, footnote 1, p.19 Stoft writes of a policy “that would ‘cap the long-term concentration of greenhouse gases [GHGs]… at 450 [ppm]‘. We are now just over 380 ppm.” CO2 alone is at “just over 380 ppm”. I can only guess whether the policy proposal referred to is to keep all GHGs at a CO2 equivalent level of 450ppm or to keep CO2 below 450ppm – which, it’s now becoming clear, would be too high.
- at the start of Ch.3, on p.21 Stoft remarks that: “Back in the 1800s… Jevons predicted peak coal in England”. Maybe it’s a cultural thing, but to me “the 1800s” refers to the decade 1800-9, inclusive. Stoft means “the 19th century”, here. Jevons in fact wrote “The Coal Question” in 1865 (Wikipedia). And, btw, he was probably talking about Britain, not “England” (Wikipedia thinks so). No offence taken.

The Great Carry Trade II: more on the Problem of China

Yesterday I explained why I consider that we’re in the midst of an era that could be termed the Great Imbalance. I go along with the the view apparently held by Nouriel Roubini that the so-called “Great Moderation” – the period of low inflation – is/was a mirage.

The point is that there is more than one tectonic shift taking place: low inflation has been caused, not by monetary conditions alone, but primarily by a historic reduction in the power of labour to raise wages and hence prices. Inequality is rising, full employment in developed countries is a half-forgotten phenomenon, jobs move around the world as part of globalisation; whereas the disruption of this supposedly happy state of affairs is caused by, well, trade imbalances.

A year ago I reported how the FT’s Martin Wolf had put his finger on the button (in fact, he’s written an entire book on the topic). Today I open my FT and see the argument outlined again, this time by Martin Feldstein in a piece titled “Why the renminbi has to rise to address imbalances”.

Feldstein argues that the US must increase household savings and China must increase domestic demand and “exchange rates must also adjust”. But this logical relationship is wrong. Exchange rates are the driver here. If the renminbi is allowed to rise against the dollar, American household savings and Chinese demand will adjust automatically.

Feldstein correctly notes that in the next phase of the Great Imbalance the euro will be drawn into the fray. The renminbi has dragged the dollar down. We’re going to start to see imports from Germany substituted by domestic Chinese (and American) products. (Europe will likely blame protectionism, and if they retaliate that would be a self-fulfilling diagnosis). Of course it will all be explained as due to the development of China, things they’re doing right that we’re doing wrong. The low dollar will be easily explained as a shift away from the dollar as a reserve currency since China will naturally hold more euros – a counterpart of its trade surplus with the region. But in fact all this will be the result of misaligned currency exchange rates!

Perhaps we should ask ourselves why China follows this policy when India does not. One problem India may avoid but China must face in the future is the sustainability of their industry. It’s all very well making things cheaply in external money terms, but we also have to consider whether they are being made efficiently in terms of physical real-world resources: labour, energy, the cost to the environment and so on. If these are being systematically mispriced – and it’s difficult to see how they could not be – then there will eventually be a reckoning, a crisis in China and a Great Rebalancing.

At the risk of oversimplifying, the difference with Japan, perhaps, is that, through successful industrial policies, Japan achieved export-led growth more by greater efficiency (such as quality) compared to the competition. This was sustainable even in the era when Japan was popularly termed “the Land of the Rising Yen”.

Feldstein’s conclusion is that:

“Fortunately, the Chinese economy is expanding rapidly and its growth is becoming less dependent on exports. When it has the confidence to allow the renminbi to rise, we will be on the path to reduced global imbalances.”

I don’t know. I think they need to start now, or maybe not to be starting from here at all. It seems to me that, in the real world, economic shifts are marked by destructive crises. We’ve probably got a few years before the wheels come off again. Or, if governments use the time wisely, maybe the train can yet be switched to a level track. Interesting times.

Virgin on the Ridiculous – and All Tied Up

Richard Branson had an entertaining comment piece in the FT today. He was complaining about Sky’s dominance of the premium pay TV channels – predominantly sports and movies. Quite right too, the UK TV market is a big mess. Both the BBC and Sky stifle competition.

One point Branson made tickled me. If the market were functioning better, he claimed:

“Those who do not wish to commit to a 12-month subscription but are willing to pay for some TV channels will be more readily able to do so.”

Readers will remember that one of my whinges about Virgin Media was that they locked me into a 12-month contract. I presume Branson won’t mind if Virgin Media as well as Sky have their wings clipped in this regard.

But what really had me rolling around on the floor was the Bearded One’s description of Ofcom’s proposal, which, naturally, he wholeheartedly supports:

“Ofcom has proposed … making Sky sell its premium channels to other operators at a fair, wholesale price. This would be an excellent result for consumers because it will enable each pay-TV operator to com­pete based on its different strengths. Services will be developed that appeal more closely to the preferences of different customers. For instance, those who do not want, or cannot have, a satellite dish will not need one. … New market segments and more innovative and compelling consumer offers will appear. And they will cost less. Under Ofcom’s proposals, some operators could plan to retail Sky Sports 1 at a price more than 20 per cent below the lowest price that channel can currently be bought from Sky.” [my emphasis]

Absolutely hilarious.

Basically I support this vision – but this isn’t the way to go about changing the industry.

The point is that if Ofcom do this (and how they dream up the wholesale price is beyond me), then it makes no sense whatsoever for Sky to remain as both a service-provider and a channel-provider.

Separating these functions (for all broadcasters, BBC take note) – i.e. splitting Sky up into a service-provider and a separate channel/content-provider – should be the starting point of regulation, not a consequence of it. Breaking down vertical integration in this way is a central pillar of “managed markets”, part of my new political-economic philosophy of “constrained capitalism”.

The central argument is that if I can choose the technology that delivers my TV service and the channels I purchase as entirely separate steps, as Branson describes, then I have 2 dimensions of choice, not one.

There are numerous markets where our dimensions of choice are limited by dominant suppliers. Supermarkets is one. I gather from the hits on my rant complaining about the Cambridge Sainsbury’s misguided promotions and on my wide-ranging discussion of attempts to reduce competition by blocking Tesco in Mill Road and of self-checkout tills in supermarkets, that supermarkets are what the world wants to read about. Back in March when I wrote those pieces I meant to add some further comments complaining about how the Cambridge Sainsbury’s in particular has been gradually replacing branded products with subtly inferior own-brand goods. In my opinion, the texture of Kelloggs’ Sultana Bran is somewhat more dissimilar to that of cardboard than is Sainsbury’s equivalent product. If Kelloggs’ product is good enough for Chris Hoy, then it’s good enough for me. Besides, the Kelloggs box fit in the space in my cupboard in Cambridge and the Sainsbury’s one did not. It was very inconvenient to have to make periodic trips to Asda to stock up on Kelloggs’ Sultana Bran when Cambridge Sainsbury’s decided to just stock their own brand.

The point is that when supermarkets used to stock only branded goods, you had two dimensions of choice: where to shop and what to buy when you got there. The supermarkets specialised in the business of retailing and their suppliers in making the best products.

But what the supermarkets have done over the years is reduce the choice to one: where to shop. Larger stores, the institution of the weekly shop by car and a battle to monopolise the best locations have made it very difficult for shoppers to choose different products at different stores.

Own-brand products are a way of capitalising on “owning” the customer. Why let suppliers have some of the profits? Even if an own-brand alternative is slightly inferior shoppers are unlikely to go to a rival just for one or two items. And after a while they may forget they preferred the brand. Of course, it may not be necessary for the supermarket to ditch the branded product anyway. The threat of introducing a generic alternative may be enough. It must, surely, allow the supermarket to improve the terms of supply and increase their profits.

In the news this week, though is the OFT’s ruling in favour of the status quo on tied pubs. Clearly the practice must increase the landlords’ profits, since, as the FT reports:

“The OFT ruling on beer ties, which obliges pub tenants to buy their beer supplies from their pub landlords at often above-market prices, boosted shares in Punch Taverns and Enterprise Inns by 14 and 23 per cent respectively.”

I doubt the stockmarket is mistaken: if the practice is good for the landlords it must be bad either for the tenant (i.e. the pub manager, referred to in common parlance as the “landlord” – don’t get confused) or the customer. Probably both.

It seems to me fairly obvious that restricting the degrees of choice by the customer must allow the landlord to improve profits. Not all customers are going to go elsewhere for a different pint of beer, though they may well buy something different if it were on offer in their local.

Different industries may have the same feature – an anti-competitive form of vertical integration – but there are peculiarities to each. In the pub business, the landlord is a monopoly supplier to the tenant. It is therefore beyond me how we can find a Simon Williams, “senior director of the OFT” saying, according to the FT, that:

“… it [is] not in the pub owners’ interests to overcharge landlords for their beer. ‘Any strategy by a pub-owning company which compromises the competitive position of its tied pubs would not be sustainable, as this would result in a loss of sales. Pub-owning companies are not therefore protected from competition by virtue of the supply ties agreed with their lessees.’ ”

No, no, no! This is mindblowingly dumb. 101 economics (again): a monopolist does not maximise profits by fully satisfying “demand”. A few seconds thought verifies the sheer mindblowing dumbness of the OFT’s assertion: by their logic the pub owners would reduce beer to a fraction above cost to sell as much as possible. No. The pub owner has an incentive to increase the price of beer until the additional profit is outweighed by the sales that are lost. As I said, many people choose their pub on criteria other than the beer stocked and its price, so the tied pub owner has much more scope to increase prices than an independent beer producer. If customers don’t like it they have to go out in the rain: they can’t simply choose a beer from a different pump.

The Guardian, I now see, also reports the OFT’s decision. As well as the quote above they report some more absurd statements from Simon Williams:

” ‘The interests of the pubco and lessee are aligned.’

This is a bizarre thing to say. In any supply-chain there is competition to capture the available profits. The interests of the pubco and the lessee cannot possibly “be aligned”.

Anyway, let’s go on:

“[Williams] pointed to pub industry closure statistics, suggesting they showed the greatest number of boarded-up sites across Britain’s ailing pub industry were free houses, not ‘tied’ premises.”

Ah, but there’s an explanation for this (well, several actually – the article notes that it is easier to replace a tenant landlord of a tied pub than a free-house landlord). My different point, though, is that, because the pubcos buy in bulk from a small number of brewers you’d expect them to be able to undercut free houses, except the big chains like Wetherspoons.* Damningly, though, Williams notes that:

“…the difference in bar prices between tied and non-tied pubs was very small — lager being about 8p, or 4%, dearer per pint in a tied house — suggesting competition was working well.

Astonishing.

And finally:

” ‘The market can deliver better than any state intervention,’ he said.”

My philosophy is that the state needs to intervene to manage markets. No-one’s talking about setting prices or anything. Yet another ridiculous statement from Simon Williams.

Until recently the state of British pubs was a long way from the top of my list of the world’s wrongs to be righted. But no sooner had I noticed that the legendary Tumbledown Dick is boarded up than I saw the Paper Moon in the same sad state.

We’re losing our history.

And a large part of the reason is because we apparently don’t properly understand competition.

—-
* Note: The buyer power of large organisations is a separate problem in the pub as well as supermarket and many other industries. I’ll discuss this another time.

Confessions of a Cambridge Shopper

I wrote yesterday about campaigns to block a new Tesco on Mill Road and a new supermarket of provenance as yet unrevealed (at least to me) on a site in West Cambridge. I’ve also commented on some of the shortcomings of the supermarkets that do exist in Cambridge.

It’s my proposition that – from the perspective of a no-car household – there are not too many supermarkets and food stores in general in Cambridge, but too few. To substantiate this argument, I am prepared to reveal to the world some of my secret shopping habits.

As I mentioned in a previous rant, I do most of my shopping at Sainsbury’s in Sidney Street, the only general mid-market supermarket in the City Centre. Because this Sainsbury’s is essentially a monopoly I have no choice but to put up with the length of queue that the Sainsbury’s management deem reasonable (they have the power to allocate more or less space, and/or more or fewer staff, to tills). Luckily for the customer, perhaps, there is little room to waste on queues in the store, so their length is limited even if – because of the lack of alternatives – the market would stand a longer wait.

But the main problem is that shelf-space is severely limited in the Sidney Street store. Sainsbury’s sometimes run out of particular lines – often as a result of their rather annoying BOGOF policy – and have an irritating habit of phasing out branded products from time to time and replacing them with their – in my opinion – inferior own-brand products. When Sainsbury’s lets me down, I either have to lump it and buy an alternative, or find the product I want at another store.

So here’s the confession part. Where else do I shop? And why?

There’s the market of course, but I’ve never really developed a rapport with any of the stall-holders. Perhaps because my father ran a fruit and veg shop for some years, I have a strong preference for choosing my own individual items, which is rarely allowed in a market. I remember once in Croydon I was “accidentally” given a bag of rotten avocados. I made sure that, while I was getting my money back, my loud complaints cleared the area of customers. Maybe it’s my suspicious mind, but I always suspect that market-traders think they see me coming, little suspecting my professional experience. I occasionally buy fresh herbs (in absurdly large quantities), an apple, or, on an impulse, some strawbs, in the market, but not much else. I just kind of feel the prices should be lower and I worry that, distracted by the melee around the stalls, I’ll end up with dodgy goods.

Occasionally I visit Asda on Newmarket Road. Unlike Sainsbury’s, this store is entirely geared up for drivers doing their weekly shop. For me Asda is a pain to get to, and queuing behind even a couple of overloaded trolleys is a tedious process. So why do I go there? Mainly because it stocks Kellogg’s Sultana Bran. Sainsbury’s used to sell KSB, but now have an own-bran alternative which a) to my palate is made of cardboard and b) comes in a taller box which doesn’t fit in my cupboard. Of course, whilst in Asda I pick up a few other items which Sainsbury’s doesn’t stock (or at least didn’t when I got in the habit of buying these things at Asda): usually Whole Earth sparkling organic lemonade and ginger beer, and Mexicana cheese (warning: contains peppers).

I even more rarely visit Tesco on Newmarket Road, which is even further than Asda. I can only remember going there a couple of times on emergency missions. The giant stores on Newmarket Road are unsatisfactory alternatives to city centre Asda, Tesco or other mid-market alternatives to Sainsbury’s.

Then, Cambridge being one of the country’s more affluent cities, we have no less than three M&S outlets: at the railway station, in the Grafton Centre and in Market Square.

Now, I’m a bit of a traditionalist when it comes to supermarkets. In my opinion they are shops, not food producers. We’d all be better off if they kept it simple and just offered as wide a choice as possible of branded products. Then we’d get the benefits of sensible competition. You’d choose your store on the basis of location and shopping experience factors, such as stock-control effectiveness, queue-length and ambience, and you’d choose your product based on what you actually want, not what the only convenient store in your area wants to sell you.

Why, for example, M&S does own-brand wine and beer is beyond me. Do not touch this stuff! My experience suggests money spent on M&S booze would be better used by making an offer to the guys in the park for whatever they’re drinking.

But life is rarely as simple as own-brand bad, branded-brand good. In particular I can heartily recommend M&S’s soups, particularly the spicy red lentil. They are superior, in my opinion, to the tired Covent Garden brand stocked by Sainsbury’s. Of course, everyone has the canned varieties from Campbell’s and Heinz, but few new recipes have been introduced by these companies since the coronation. Of Queen Victoria. The best soup I’ve ever bought in Cambridge was borsch at the International Food Store on Mill Road, but sadly supplies of this delicacy are sporadic, to say the least.

It’s convenient to pick up some M&S soup at their busy little store at the Railway Station, but that outlet doesn’t stock the most important product I buy at M&S: their Unsweetened Fruit and Bran Muesli. As I’m allergic to nuts, it’s a big deal to identify a satisfactory nut-free muesli product (I used to buy some Jordan’s lines). Now, the Grafton Centre M&S food-hall is about to close and relocate to Newmarket Road, so to avoid a trek, I now rely on the Market Square M&S for my muesli supplies. Let’s hope Sir Stuart Rose doesn’t decide the Market Square space would be more profitable if stocked with bras and knickers.

And, while we’re upmarket, there is a Waitrose in Cambridge, but I’d need to drive to it. The John Lewis store, disappointingly, has no food-hall. As I said, there are not enough supermarkets in Cambridge, not too many.

I shouldn’t forget the farm shop that has recently opened at the junction of Lensfield Road and Regent Street. Handy, and I regularly pop in for a treat. But I couldn’t afford to do all my shopping there.

It’s a curious little area, because mere yards from the farm shop, along Hills Road (there’s a map in one of my previous posts) we head what I can only call down-market. It’s convenience-store land. On one side of the road is a One-Stop. Handy for picking up a paper on the way to the railway station, where the WH Smith’s cannot be relied on to be queue-free (funnily enough, they have a monopoly on the station – anyone spotting a pattern, here?) – the managers who decided it would be a good idea to scan newspaper bar-codes and vetoed an honesty box for payment in the Cambridge Station WHS should be fired, and their pensions confiscated. Occasionally I’ve picked up a snack, a stale dough-nut perhaps, in the One Stop, but not much else, though I have noticed it would be an excellent place to pick up that really tacky card, for when you want something so bad that it’s good.

For emergency purchases, I prefer to cross Hills Road to the Co-op. It’s good for fresh cream and, when I spilt a glass of red wine, the internet recommended diluting it with white. It took a whole bottle, but did the trick. I defy anyone to locate the original spill. Thanks to Co-op for that bottle of cheap white wine! Judging by those ahead of me in the queue – and on the my few visits to the store I’ve had plenty of time to ponder – some use the Co-op as their main shop. This seems a bit of a stretch to me.

Mill Road is good for more than just borsch. All kinds of delicacies are on offer, from Polish sausages to caviar! Arjuna is good for spices and lentils. And there are plenty of convenience stores – Nip-In is good – though I most often pick up milk if I’m short from my newsagent on Regent Street, which is nearer.

But the general picture must now be clear. I actually have only one practical choice for my main supermarket shopping – Sainsbury’s. I’d say Cambridge has too few supermarkets, not too many.

It seems to me that the planning system is not the right mechanism for determining how many supermarkets we actually need. Surely if someone thinks a new store is viable – that they could run it profitably – then the default position should be that they are allowed to do so. Then we can all choose whether or not to use it.

The major public concern seems to be that a chain (Tesco most likely) succeeds in executing the Starbuck’s business strategy of dominating an area by monopolising all the available outlets. But, assuming that at least some people would choose another coffee-shop or supermarket in preference to Starb’s or Tesco, this strategy can only work if the number of outlets is limited. It’s much better for competition, then, if planning permission is easier to obtain than if it’s more difficult. Commercial rents will tend to be lower, and some business models – such as independent coffee shops and specialist food stores – will be more viable. And we might all spend somewhat less of our lives queuing.

Dear Sainsbury’s. Just. Put. The Price. Of Warburton’s Seeded Batch. Back. Up.

Maybe I should start Twittering, as perhaps I’ve already said what I want to say – and I was able to use the letter format again. Nevertheless, I’ll explain, since I consider myself a trainee Undercover Economist, although I prefer to point out failures rather than successes. I’m just a monitor evaluator kind of guy!

A little earlier on – before I was distracted into a short riposte in order to save capitalism – I stopped by Sainsbury’s in the centre of Cambridge.

One of the key items I wanted to purchase was a loaf of Warburton’s Seeded Batch (WSB) bread. I don’t consider myself overly fussy, but, after a long period of trial and error, I have established a clear preference for this particular loaf.  A slice toasted and with marmalade goes nicely with a cup of tea in the morning.  I recommend WSB, though it may not be the right bread for everyone. A while ago I was mildly concerned when a report suggested that WSB contains more than the average amount of salt compared to other loaves.  But in the end I found myself laughing in the face of excess dietary electrolytes.

It was around the time of the sodium chloride exposé that Sainsbury’s started a promotion: £1 rather than £1.51 for a loaf of WSB. Over several months when this offer has been in place much of the time, I have never once succeeded in profiting from it. The casual observer might notice that Cambridge is full of students, for whom the chance to save 51p is an opportunity not to be passed up. Loyal customers end up suffering. If there is a logical, Undercover explanation for this pricing policy I have not yet identified it. Today the inferior and more expensive (£1.59) product I ended up with is a Hovis Granary Original. Original in the sense that it was apparently unevenly sliced by hand.

Does the manager of Sainsbury’s in Cambridge city centre understand supply and demand? The idea surely is to find the highest price at which the day’s supplies of WSB sell out just before the shop closes, disppointing the minimum number of customers who may choose to shop elsewhere next time. Or, perhaps the price should be that at which profit is maximised, although, given the cost of clearing unsold product and, again, the risk of losing customers, this may be at the same point. Reducing the price to £1 and selling out by lunch-time on many days over a period of months does not seem to me the most intelligent promotion. What about giving free sample slices instead?

The Cambridge Sainsbury’s manager is obviously a bit of a keenie. Today he was also offering lemons at a special price of 10p each! What is this, the Soviet Union? Don’t we import citrus fruits from around the world in order to provide a constant supply? Is a promotion really necessary? Cambridge is an international kind of place. Are there perhaps potential lemon customers who’ve never tried one, and may baulk at 30p for a strange subtropical fruit? I suspect the true explanation is a glut of lemons in the store-room after over-enthusiastic marketing of the ingredients for pancakes with lemon and sugar for Shrove Tuesday a couple of weeks ago.

But that doesn’t explain the pile of cross-cut shredders (for paper, I presume, rather than lemons) at £10, reduced from £29.99, that I nearly stumbled into on my way out of the store. What is this? A recession warehouse clearance outlet or a supermarket?

One wonders what the manager of the Cambridge Sainsbury’s does understand, as the store can’t be accessed by car, so those shopping there arrive by bicycle or on foot. Many customers are students who, by and large, do not have access to a freezer, or at least a secure one. Why, oh why, then, all the BOGOFs and other offers on heavy, bulky items? Tomato juice is my “favourite” of the “offers” – I say it is an “offer” as this one has been in place for years, it seems. I enjoy a slurp with lemon juice (am I lucky today!) and Worcester sauce before dinner. But there is a significant saving – relative to the price of industrially squeezed tomatoes, that is – if you buy 3 cartons at once. Is there a car-park outside the Cambridge city-centre Sainsbury’s full of SUVs owned by the purchasers of these cartons? No, they have to lug them home on foot or bicycle. Smart. But this is less an offer by Sainsbury’s than a payment to the customer for tomato-juice storage.

The Director of my MBA programme was fond of pointing out that, on more than one measure, the Cambridge city centre Sainsbury’s is the busiest in the country. Part of the reason, I reckon, is that rents in the centre of Cambridge are so high that only a small number of competing food stores would be profitable.

Because it has a de facto monopoly, there’s no way to tell whether or not the bizarre pricing policies at the city centre Sainsbury’s are what the market wants. True, there’s an M&S foodhall, but that serves the sort of people – of which there are quite a few in Cambridge – who don’t go to Sainsbury’s. And vice versa.

True also, there are a couple of other food stores near where I live, a little way from the centre, but I always feel I’m in a movie when I go to them. The sort of movie where men with guns walk in and shoot the place up.

Competition would be somewhat improved, I suspect, if campaigners hadn’t objected to Tescos plans for its store on Mill Road (the store will open, I understand, but without some of the facilities Tesco wanted). At least some people would have a practical choice between the new Tesco and Sainsburys.

Denying people a choice of shop hardly seems democratic to me. Where is the need to apply the political process? – shops are not mutually exclusive.

The idea seems to be to preserve “independent” stores in Mill Road. Why the locals want to pay over the odds for milk is beyond me. And isn’t it possible that the specialist food stores on Mill Road would benefit from freeing space up from staples for higher value-add specialist products?

The concern is that Tesco would be too strong a competitor – as I pointed out en passant to my MP, if we bar Tesco from the location are we saying that we’ll close down the nearby Co-op if it sharpens up its act?

But the way to level the playing-field is to eliminate distortions of the market for – say – milk due to supermarket chains’ buyer power. If smaller retailers are at a disadvantage this should be addressed by the competition authorities, not through the planning process – as I noted in another context earlier today, the planning process is overused – arguably abused – in the UK.

I expect, insofar as the anti-Mill Road Tesco campaign has achieved its objectives, it will be counter-productive as the specialist food-stores, cafes and so on on Mill Road – which does have character – would gain more from passing trade to and from Tesco than they would lose to the new competition.

Cambridge is clogged with traffic, and it is also part of the environmental agenda to get people out of their cars.  Blocking companies’ plans for local food stores seems a perverse way to achieve a transport modal shift in the town. Green revolutionaries needs to be a bit smarter than this.

Turning the UK housing market

The housing market has been a British obsession for far longer than it has in the US.  A few years of “flipping” and they all suddenly go “underwater”.  Amateurs!  And the proper expression for “being underwater” is to be “in negative equity”.  “Underwater” is baby talk.

But the Brits know less about the behaviour of markets than the average American kindergarten kid.  Thus, as one contribution to a flurry of debate on the issue, an Independent editorial this morning suggested policies to slow the house-price fall are the right medicine.

The Government does indeed (as noted towards the end of yesterday’s post) seem to be following the Indy’s prescription by allowing Northern Rock to write new mortgages.

The divergence between the mainstream media and informed opinion on this issue is rather striking.  The Radio 4 breakfast-time programme, Today referenced the Indy’s daft editorial, but the vast majority of comments from the public say house-prices need to fall further.  They see the Government’s attempts to stimulate the market as what they are: panic ahead of the next General Election.

To be fair, the Indy’s own columnist, Jeremy Warner, on whose blog I was once again unable to post my thoughts, did question his own newspaper’s official stance:

“One way or another, the debt overhang of the boom has to be removed before a proper recovery can begin. The short, sharp shock approach may have something to commend it over the long, slow agony all this political meddling promises to deliver.”

Too right.

But what got my attention this morning was Today’s reference to Polly Toynbee’s column in the Guardian.  She suggests that:

“Now is the time to tell people that house prices will not be allowed to go mad again. Announce a tax to be imposed on future gains (not retrospectively). There are plenty of ways to do it. Some administrations impose an annual tax, including many US states. Some urge a land value tax system. It would be easy to impose capital gains tax on all future rises: that 18% on any inflation in value, only to be paid on selling it, could stop another bubble. The money raised could be earmarked for building social and private rented homes, or helping others to buy.”

Polly’s on the right track, but not quite there.

Here’s my recommendation.  I identify a number of steps in the line of reasoning:

1. The construction industry is a significant part of the economy. Restarting it would therefore be a large step towards ending the recession.

2. The Government could and should make life easier for the builders, as I’ve discussed in a previous post, but a full revival will only take place when house prices stop falling.

3. Falling markets in general recover only once “clearing prices” are reached, as the Yanks understand.  Things have to stop getting worse before they can improve.

4. Anyone struggling to repay a mortgage can do so for only a limited period of time.

5. Our problem is not that house prices are now falling, it’s that they rose too far in the first place (relative to earnings), at least at the low end of the market.

6. There are new “rules of the game” – purchasers are going to need a deposit of at least 10% and will find it difficult to obtain a mortgage for more than 3x salary.  This is as it should be, of course.

7. Points 5 and 6 imply prices have a long way to fall.  Points 1 thru 4 imply that the faster we get there the better.  So what could the Government do to encourage prices to fall faster?

8. The best changes are those that the market needs permanently.  I suggest two are appropriate:

9. First, abolish stamp duty, immediately (April 5th this year).  This is a tax on transactions and discourages people from moving, not just to take up opportunities for work, but also to somewhere more appropriate to their needs when their circumstances change – for example, to a smaller property when the kids leave the nest.

10. Second, announce that capital gains tax (CGT) will apply to all house sales completing after April 5th 2010.  This will encourage people – for example, those with bigger houses than they need, perhaps as an “investment” – to sell before the end of tax year 2009-10, getting the market moving immediately.  It would also give sellers an incentive to mark prices down, since they will lose some of the profit if they don’t sell in time.

11. My prediction is that, following steps 9 and 10, house prices would fall steeply, bottoming out around the time CGT is introduced.

It’s the Construction Industry, Stupid!

To help revive the UK economy, the Government should change the rules to encourage more house-building for the private market.

Back in the early 1980s, I occasionally asked members of hard left groups, such as the Militant Tendency, how they proposed to lift Britain out of recession. I recollect that, after the mantra: “Nationalise-the-top-two-hundred-companies!”, their prescription was massive investment in the construction industry. They had a point.

Some of the objectives of the raft of economic measures the Government has announced are absolutely correct. Broadly, their aim is to short-circuit the process of reduction in bank-lending (“deleveraging”) which would otherwise occur. Renewed bank lending will hopefully slow the disastrous cascade of bankruptcies leading to further bankruptcies, for example, amongst failed companies’ suppliers and customers.

The Government hopes that renewed lending will also stimulate new investment and consumption, thereby promoting economic recovery. But where will economic activity increase in the UK? Financial services is on its knees, the car industry is practically mothballed and, from retail to aerospace, most other industries are seeing reductions in demand, albeit less dramatic.

But there is huge unmet demand for housing. Waiting lists for social housing are at record levels. At the same time unemployment is heading towards 3 million. A naïve observer might suggest trying to tackle both problems at once. They’d be right.

So far the Government has attempted to address only the demand side of the housing market. Margaret Beckett is even, disgracefully, trying to scare first-time buyers into taking the plunge. But demand will only return when prices drop to a level justified by the new reality. Currently, sellers are marking house prices down by an average 2% a month. This rate may slow later in the year, but is so high it suggests prices are likely to fall for quite some time, until first-timers can buy for 3x salary, and enough of them have saved a hefty deposit.

Perhaps Beckett does not clearly understand that we have entered a period of consequences. The fact that house prices are falling rapidly now is a result of past mismanagement of the market. The Government is clear that we can’t return to the lax lending practices of the past. Quite right. It follows that the housing market will not return to its previous state.

Many commentators (and it seems Government ministers) appear to confuse the bubble phase of the housing market, when supply constraints inflated prices, with the current crash, when all that really now matters is affordability and hence demand. Observe how the oil price is behaving in a similar way to the UK housing market – the fact that we couldn’t get the stuff out of the ground quickly enough a year ago is suddenly entirely irrelevant.

The UK housing market differs from a number of others in that there was no oversupply during the bubble years. On the contrary, many first-time buyers were priced out of the market. It matters not a jot now whether there are 1000 properties on local estate agents’ books, or 10, if no‑one can afford to buy any of them. First-time buyers still can’t enter the market because, quite rightly, mortgages are harder to obtain and require a significant deposit. Unless the Government plans to encourage lenders to reinstate 100% mortgage deals, house prices will tend towards a new equilibrium level, at least in relation to average wages. The Housing Minister should be considering now how to change the rules of the game in order to incentivise developers to build houses for private sale in the lending conditions likely to prevail for the next 10 or 20 years.

Reading Margaret Beckett’s words: “If demand starts to turn up before supply turns up, you’re immediately back in inflationary pressures… when the upturn comes, there will probably be a mad rush”, it starts to dawn on me (to my horror) that the Government might be happy to see a lack of house-building for private sale. This is a mistake. Instead, the Government must do everything it can to promote house-building. In terms of the effect on the housing market, the pay for the jobs created would more than compensate for the increased supply of housing, since the full cost of construction has to be paid out when property is built (i.e. put into the economy now), but this money is borrowed (i.e. is only taken out of the economy in the future), first by the developer and later by the purchaser of the house.

So, encouraging a bit more house-building now would be a very good idea. The problem is that, not only is the housing market in freefall, the Brown Government has already splashed money about remarkably liberally. Rather than devise ways to help the banks raise fresh private capital by, for example, underwriting deeply discounted rights issues, the Chancellor has simply reached into the taxpayer’s pocket. The pound is now under pressure and concern about the fiscal deficit will make it more and more difficult for the Government to borrow. Consequently, the Government is not in a position to finance a massive social house-building programme, much as it would like to. But they could change the rules to reduce costs to developers, encouraging them to build more houses.

The reasons why there is so little house-building now are the same as during the bubble years. Then, the lack of supply inflated prices more than would have otherwise been the case, contributing to the mess the economy is now in. Now, more house-building would help the economy out of recession.

First, the local planning process is seriously dysfunctional. The Government should redouble its efforts to speed applications along. Unfortunately, there is stiff resistance to the necessary measures, and I also suspect the Government is in something of a bind, as one of their aims is to empower communities. The trouble is, when it comes to planning, “local democracy” is a contradiction in terms. Decisions are overly influenced by the concerns of anxious neighbours – often bordering on the ludicrous, for example, in terms of sensitivity to increased traffic – to the detriment of the general interest in adequate housing provision. At a minimum, the Government needs to constrain the planning process to restrict the grounds for objection. For example, objections on grounds of supposed traffic increases should only be admissible if a new through-road is being created.

Second, the level of house-building is much reduced by Section 106 agreements with Councils, whereby developers fund, not just supposedly necessary infrastructure improvements, but also the provision of new social and “affordable” housing. Section 106 taxes inevitably reduce the supply of housing because (as would be learnt in an Economics 101 class) restricting developers’ profits will, as sure as economic gloom follows euphoria, result in less investment in house-building. To try to increase social housing provision through such a measure as Section 106 is a colossal blunder, since, by reducing the overall supply of housing, more people end up on local authority lists because of the lack of supply to the private purchase and rental markets (and consequent high prices), than if Section 106 schemes to provide “affordable” homes didn’t exist! The Government should stimulate house-building by drastically restricting the ability of local authorities to, in effect, tax first-time buyers through Section 106 agreements, and permanently abandon the use of this method of funding “affordable” housing provision.

If the Government were to take these steps, house-builders would judge many more potential projects to be commercially viable than would otherwise be the case. For many developments, they would be able to reduce their costs sufficiently to be able to sell the property profitably when the housing market stabilises in a year or two. Developers would have an incentive to make use of the bank-lending the Government is encouraging and restart the house-building industry, providing a much-needed stimulus to the economy in general. The increased economic activity from a revival of the house-building industry would itself contribute to arresting the decline in house prices.