Catalonia? I am confused

Published on 17/9/17:

This weekend I realised that some of my international friends are confused by what's happening in Spain with Catalonia. I hope this helps:

-Spain is a western democracy and its Catalan citizens vote frequently. In fact, between European, national, regional and municipal elections we have voted 6 times in the last five years.
-In the last regional election, pro-secession parties decided to unite around a single issue- independence- and not only failed to win a majority of thevote, but also lost votes relative to the prior election. Polls, even those paid for by separatists, show support for independence is a minority and in decline.
-Catalonia is not "oppressed". It is one of the most prosperous regions in Spain and its citizens enjoy a high standard of living and one the highest degrees of self-rule of any region in Europe.
-The party that traditionally ran the regional government of Catalonia has, for the last 30 years, used public money to promote a separatist agenda through education and local media and has illegally funded itself with a corrupt scheme where contractors had to pay bribes of at least 3% of any public work.
-The region of Catalonia has never existed as an independent political entity and was a part of the Kingdom of Aragon, which merged dynastically with the Kingdom of Castille in 1492 to create the Spain we know today. There is no "union", as in the UK- Catalonia is to Spain what Rousillon is to France or Cornwall to England.
-Spain is a parliamentary democracy, with a constitution that can be amended. A vote on territorial secession would require such amendment and the support of a qualified majority of Spaniards.
-Not a single country or international organisation, with the exception of Nicolas Maduro in Venezuela, has supported this movement. 

So why the fuss? As the economy improves and support for independence wanes, the separatists are afraid of "missing the train" and, breaking Spanish and regional laws, have embarked on a campaign to present the central government as "evil", for not allowing a regional referendum which does not comply with the constitution (overwhelmingly approved throughout Spain, including Catalonia). This noise also conveniently masks regional corruption scandals and sets up the separatists as victims for the next regional election.

Social engineering and the "Programa 2000"

Most foreign observers believe that many people in Catalonia have a deep-rooted historic love of their region which makes them have spontaneous nationalist emotions. I think they have missed the fact that, for over thirty years, a carefully designed social engineering programme has been executed by the nationalist regional governments which have ruled the region for most of that period. These plans were kept mostly in the dark, but already back in 1990 it emerged that a plan named “Programa 2000” had been put in place by the leaders of the main Catalan nationalist party, “Convergencia i Unió”, with the objective of promoting the long-term “recatalanisation” of society. This plan, whose main details are attached here, included taking control of education, regional media, administrative, political and economic institutions and using these to create a “national collective identity”. The success of such a policy has been globally apparent in the events of the last weeks, but for those of us who live here, it has been the case for many years.

One may ask why the central government let this happen, if it was so obvious. In fact, one of the main culprits of our current predicament has been a decentralised political system which encouraged an exchange of votes, whereby the regional nationalists supported whoever was in power in the national government, in exchange for laissez-faire in the regional government. Such short-sightedness has cost us dearly and contributed in no small measure to lead us to where we are today.

The "Tabarnia" construct

Yuval Harari pointed out in “Sapiens” that humans are unique in their ability to create abstract constructs such as religions, corporations and nations.

The region known as Catalonia has recently ceased to exist as a unified construct thanks to the polarisation brought about by separatism. Today, its citizens are completely divided on what “Catalonia” means, as the recent regional elections have demonstrated. There are now two clear constructs. The urban, mostly coastal, areas voted clearly in favour of remaining within Spain (and Europe by extension) and a bilingual, inclusive society; whereas the rural hinterland voted for exactly the opposite. In fact, a new construct called “Tabarnia” (Barcelona + Tarragona) has recently arisen within the former group, claiming their right to independence from the latter. 

One of the delicious ironies of “Tabarnia” is how swiftly the separatists have angrily retorted that Catalonia is indivisible and that only the “Catalan people” as a whole can choose the destiny of Catalonia, using the same arguments they have been quick to dismiss when used by the central government. 

Then again, logic has never been their forte.

La ironía del rescate de los bancos

Para los aficionados a las tertulias financieras:

1. El Estado no ha rescatado al sector bancario- ha rescatado a las antiguas Cajas de Ahorro (a casi todas).
2. La gestión de las Cajas de Ahorro se había poblado de políticos y sus amigos/familiares.
3. Los gestores, no siendo profesionales, decidieron prestar dinero a deudores que no podían pagarlo.
4. Como las inevitables pérdidas superaban el capital que tenían las Cajas, había riesgo de su extensión a los acreedores, que son los depositantes.
5. Para evitarlo, el Estado inyectó capital (directa e indirectamente), asumiendo esa pérdida.
6. Los gestores de estas Cajas fueron despedidos y, en casos de mala fe, juzgados y condenados.
7. Por tanto, los “rescatados” fueron: (i) los deudores que han disfrutado de algo que no pagaron y (ii) los depositantes que, a pesar de lo anterior, han recibido su dinero igual.
8. Una alternativa hubiera sido que muchos perdieran su dinero por haberlo dejado en una entidad donde los gestores lo prestaban sin tener ni idea. A mí me hubiera parecido razonable, pero, en un país en el que, si la nieve resbala, es culpa es de otro, imagínense la que se hubiera montado.
9. Ahora, los propios “rescatados” son los que claman al cielo con el “rescate de la banca”. 

Lo que hay que oír.

"La Nacionalitat Catalana"

Para entender cómo piensan muchos separatistas catalanes, es imprescindible leer “La Nacionalitat Catalana” de su ideólogo de cabecera, Enric Prat de la Riba. Es un fascinante panfleto de principios del Siglo XX en el que el autor repasa lo que entiende por una “nacionalidad” y explica por qué Cataluña lo es. Explica también que la represión tras la Guerra de Sucesión oprimió al pueblo catalán hasta que su cultura resurgió en un espontáneo “renacimiento” (básicamente coincidiendo con el Romanticismo de finales del IX). El libro entero es un compendio de victimismo (“Castilla” nos ha oprimido), revisionismo histórico (la Edad Media era maravillosa), imperialismo (las naciones civilizadas tienen que dominar a las bárbaras), admiración por el nacionalismo alemán (el “Volkgeist” o espíritu nacional) y supremacía (los catalanes somos diferentes y mejores); todo en la mejor tradición del fascismo español.

Para leerlo se encuentra en:(http://eapc.gencat.cat/web/.content/home/publicacions/varia/24._la_nacionalitat_catalana/nacionalitat_catalana.pdf) .

"In, Inde, Independència!"

I originally wrote this at the end of September 2012 but declined to post it because Spain at the time was in the throes of a serious financial crisis and in my professional position, a personal opinion of this nature may have been counter-productive. Five years-on, however, I feel the debate is out in the open and this may be a minor contribution to it.

Greetings, o’ loyal reader. It has been a long time indeed since I last wrote in my blog. Partly this is due to new demands on my time from a new family member but, more importantly, I have been constrained due to my current professional activity. I have a fiduciary duty to my employer and, as such, I need to keep most opinions to myself.

However, I have been raised from my quiescence by the recent sight of almost one million people clamouring for independence in Barcelona. Reflecting upon this event, I remembered a good friend and former MBA classmate who, as an advertising executive, revealed to me the art of his profession. “Blood, sex and money”, he said. These are the primal instincts that move people. Appeal to these and you can move mountains. Blood. Sex. Money. Think of all the cases where rational argumentation is futile because it directly attacks one’s feeling of belonging (religion and family?). Think of all the cases where rational thought is put away in order to pursue a sexual fantasy (Bill Clinton and Dominique Strauss-Kahn). Think of all the cases where civilised behaviour is eschewed in the pursuit of power and status (too many to mention?).

I pondered upon this when I tried to get another friend to explain to me why he defended the idea of an independent Catalonia. After failing rather miserably to present a rational argument he ruefully admitted: “It’s a question of feeling”. He was not able to rationalise an independent Catalonia, he worshipped an independent Catalonia. At this point, I realised that no rational argument was ever going to waive his conviction, his feeling of belonging, his kinship with the tribe.

Against irrational and emotional arguments that have set in people’s minds it is almost impossible to win. Think of religion- how many mad ideas are floating about which are plainly ludicrous, but whose mere criticism can place you at risk of death? This, unfortunately, is the situation that we have to deal with in Catalonia. There are limited ways of dealing with this problem and one, force, is clearly not an option in today’s environment. Yet other options exist and only require the political will to be implemented. Aligning incentives- both positive and negative- is clearly an option. The threat of a Spanish veto to a Catalonian entry to the EU is an example of negative incentives but these are not sufficient. Are positive incentives not available? Don't we have examples of how Catalonia has prospered within Spain? Many are available but few publicly abound.

Finally, the propaganda apparatus of the nationalists should also be deactivated, probably by cutting the access of public funds for these means. But also by using pro-Spain advertising and marketing. The population in Catalonia currently only have access to one side of the story.

In theory, the debate is centred around the fiscal"theft" that the rest of Spain inflicts upon Catalan taxpayers. Leave aside the obvious point that many of those claiming redress are net tax recipients rather than contributors. What is clear is that tax rules are the same in Spain as in Andalucia and as a consequence residents in Catalonia pay more because they earn more. Again leave aside the argument that part of the reason that Catalonian residents pay more is because of many large corporates selling to the rest of Spain are based here (Madrid, by the way, contributes far more for exactly the same reason).

So the gripe is about expenditure and "justice". Since 1978, Catalan nationalists have been asking for transfers of decision making, which has been achieved to an extent unknown in any jurisdiction I know. I can't, for example, think of a single instance of a region that does not permit public schooling in the national language, despite parental demand for optionality. Once most decision making power has been transferred, the issue is whether these powers are administered efficiently. It is pretty obvious that successive governments have done at least as badly as the national governments in managing expenditure.

One obvious source of expenditure reduction would be to recentralise some decision-making power but that is not an option, which shows that the debate is not really economic but more a smoke screen to hide the ultimate ambitions of the puppet-masters of the demonstration: secession. Time will tell.

Bread today can bring hunger tomorrow

The above phrase is a literal translation of a Spanish saying: “pan para hoy y hambre para mañana”. The closest sensible translation I can think of is “laugh now, cry later”… a typical Southern European attitude to problems which makes this part of the world a great place to live in. Sometimes, however, we can get carried away with “laughing” by adding a few boosters (such as consumer or housing debt) so that the “crying” can almost develop into “dying”. While I write this facetiously, I think we have experienced too many excesses in Spain over the last decade.

How have we Spaniards managed to focus on today at the expense of tomorrow? Here go three of my favourites:

1. Dependence on the construction and housing sectors

This is a sector that cannot be competed away via trading and has thus avoided the impact of globalisation. It also happens to be low value-added labour intensive so that job-creation was an added bonus. Politicians of all sorts became chummy with construction “entrepreneurs” in a fatal embrace which was to show itself to be unsustainable. There were few incentives to improve education and competitiveness to face increasingly assertive emerging markets.

“Pan para hoy y hambre para mañana”

2. The use of deferred payment mechanisms to finance the above

The main constraint to the above policy is the availability of finance. Fortunately, central bank policy across the Euro area meant that money could be thrown at the above sectors in the form of both development grants from the European Union as well as financial debt provided by foreign financial institutions and other long term investors. To ensure that the volumes of debt being thrown in did not scare these foreign investors away, the funding was conveniently disguised into debt issued by local financial institutions, infrastructure “public-private project financing” and corporate debt of construction companies. I will not provide figures in this post but take my word for it. The volumes involved are huge. One flaw in this policy- debt has to be repaid and we cannot devalue our currency.

“Pan para hoy y hambre para mañana”

3. The restricted list method for choosing political representatives

The intellectuals who designed the post-dictatorship constitution decided that they wanted to strengthen political parties in the light of the inherited power of the Armed Forces, the Catholic Church and other reactionary elements. This might have made sense at the time, but it has since developed into a mockery of democracy where candidates owe their loyalty to the party that includes them in the list and not to the electorate. As a consequence, political parties have become so strong that they have weakened the very fabric of society. There are few, if any, genuinely independent institutions in Spain, including the judiciary and the press.

“Pan para hoy y hambre para mañana”


Change is necessary but I don’t think that change will come naturally. Those that benefit from the status quo will not voluntarily become the agents of change. Change will only come about if forced by circumstances or outsiders. This was and still is my great hope for the crisis. A renewed commitment to envision, propose and create a genuinely liberal society where basic rights are enforced, responsibility is assumed, and creativity and freedom from coercion genuinely flourish. After all; who wants to build a house on sand?

The Big Lie

Yesterday's Goldman Sachs results have been illuminating. The investment bank that everyone loves to hate produced record returns for its shareholders (and management) with a quarterly profit of USD 3.4bn . Its prowess in financial markets trading is unparalleled in the finance world and they certainly deserve it...or do they?

An institution that was on the verge of bankruptcy just nine months ago and required public financial assistance is now producing record profits and paying oversized salaries to its top management. It seems that many financial institutions will follow suit in the coming quarters. Where are the returns on the public investment?

The “Big Lie” that we have been fed by a compliant press is that the stimulus packages which have been implemented in major economies were designed to support the real economy. In fact, these packages have been used primarily to prop up the banking system, a worthy aim in itself had not the main beneficiaries been shareholders, bondholders, and management. In plain English, taxpayers have had their pockets picked to support investors and top management in financial institutions.

I think that no reasonable economist can disagree with the need for the government to step in to save the money centre function of banks by safeguarding retail deposits and clearing relationships, but I can see no worthy use of taxpayer funds in supporting the financial rewards of institutional investors and management. The latter, after all, are trading risk for return. In 2008, after many years of return, risk reared its head and proceeded to destroy the value of financial instruments in a violent and unprecedented move. In my opinion, it is only fair that financial rewards for shareholders and management should have been wiped out. It is a basic premise that owners and management are responsible for the actions of the financial institutions they control.

Not content with direct assistance to the industry, monetary authorities have also stepped in to ensure that banks quickly start making money. How is this achieved, you may ask? It is as simple as enabling the carry trade...central banks have flooded markets with liquidity so that short term interest rates have collapsed. Banks can then borrow cheap short term money and lend longer term without taking on much risk. Call it a licence to print money.

Ostensibly, the policy of cheap money was designed to save the real economy but I don’t believe that a real investment project is sensitive to rates at levels below 5%. The only institutions that measure returns in basis points are financial institutions, given their high leverage and portfolio of financial assets. The fact is that rates have been reduced with massive liquidity injections because they assist in the repair of banks’ balance sheets by providing access to carry trade income. Again, governments have used public policy tools to protect well connected shareholders and top bank management.

Further evidence of mis-use of public funds is implicit in the conflict of interest of regulators. Ask these questions: How many of the financial sector regulators own or have friends/relatives that own substantial stakes in bank shares? Are they chummy with top management or do they get access to perks? I suspect that regulators are responding to hidden incentives in many instances....help your friends and they will help you; with a job in the future, or maybe access to holiday homes, yachting holidays and “business” opportunities.

In Spain, the lack of freedom of press has led to few and far between debates about the convenience of using tax-payer funds to save bank shareholders and stakeholders in Cajas. When referring to stakeholders, I include management and the political establishment which has benefited from the largesse provided by directing savings from depositors. Much in the same way that industrial companies used to own banks in order to provide cheap funding for their industrial activities, politicians have continued that ancient tradition to channel funds to pet projects. The lack of debate regarding the recent restructuring fund set up by the government has been egregious.

We live in a world in which society at large has been skimmed to pay for the returns of stakeholders in banks: so called sophisticated investors and management. Once more, prudent economic agents have had to bail out the aggressive imprudent agents, reinforcing the moral hazard which will inevitably encourage the next financial bubble under this “let’s socialise the losses and privatise the profits” policy.

Spanish party politics...and I'm not referring to "fiesta"

Let’s take a look at why Spain is going the way of Citigroup. I think it is important so that once the crisis is over, politicians and institution builders are able to recall history and avoid past mistakes.

First, the Spanish political system is reminiscent of nouveau riche antics. It was developed and executed in the latter part of the 1970s, when the combination of ideological enthusiasm and democratic inexperience led to the creation of a political system that has outlasted its usefulness. The ideologues of the system wanted strong parties, regional representation and democratic principles as the basis of the system. Over the years, strong parties and regional representation have cast out principles-based management to create a system that is on the verge of moral bankruptcy. Check out this link:
http://www.elpais.com/articulo/opinion/maquiavelico/sistema/electoral/espanol/elpepuopi/20080216elpepiopi_11/Tes

Today, over 30 years after the death of Franco, the key indicators of health of a democracy such as voter turnout and strong independent institutions are weaker that at any time in recent history. A primary reason for this democratic deficiency is the Spanish electoral system. Numbers always help; let’s look at the results of the March 2008 elections (click on image):

Several conclusions can be drawn from this table. The first column in red provides the percentage number of total seats assigned to each party. Note that PSOE and PP each were assigned 48.3% and 44% of the seats, despite obtaining only 43.9% and 39.9% in number of votes, respectively. Note also that Izquierda Unida was assigned only 0.6% of the seats despite obtaining 3.8% of the popular vote. Therefore, large parties and strong regional parties are over-represented, which inevitably leads to under-representation of dispersed national parties such as Izquierda Unida and UPyD. Another disturbing fact is that 4.1% of the people who voted had no representation whatsoever. When you add this voter base to the 24% of registered voters who abstained from voting, an astounding 27% of registered voters are not represented in the Spanish parliament. Surprised?

Spain has 52 electoral districts (or circunscripciones) with 2 representatives allocated to each and 248 distributed on the basis of population, for a total of 350. The d’Hondt method of seat allocation ensures that the strong candidates within these electoral districts get elected. As a result, strong national parties and regional parties are over-represented in contrast to parties which have a voting base spread across all the electoral districts. The d’Hont method works like this:

-Within each electoral district the first seat goes to the most voted party
For calculation of the second seat allocation, the party that obtained the first seat divides its number of votes by the number of seats obtained plus one (i.e. two).
-The second seat is then allocated to the most voted party (note that, under 2 above, the party that got the first seat has halved its votes for calculation purposes)
-For calculation of the third seat, the party that obtained the second seat divides its number of votes by the number of seats previously obtained plus one (i.e. if it is the same party that got the first seat this would be three, otherwise it would be two)
-The process is repeated until all the available seats are assigned.
-For mathematical minds the test for allocating each seat is based on: V/S+1; where V= number of votes and S=seats previously obtained

Therefore, we have an electoral system that is not representative, at least for many people. Strong parties and regional parties have run the country for 30 years and made it what is now, a nation which is close to becoming a banana monarchy.

To add insult to injury, a closed list system has also been implemented. In closed list systems the party has pre-decided on who will receive the votes in the elections, that is, the candidates positioned highest on this list tend to always get a seat in the parliament while the candidates positioned very low on the closed list will not. There are no prizes for guessing to whom candidates owe their loyalty. It’s not to the voter.

The outcome of this electoral system is plain for all to see, yet the players involved have no desire to change a system that works to their benefit. Why would the PP or PSOE want to change a system that allocates them disproportionate influence? Regionalists, in turn, have wielded their power in national politics to force the central government to transfer power to the regions, regardless of whether this was efficient or effective. Why would the regionalists want to change this system?

Therefore, it is highly unlikely that the system will change, unless a political crisis forces change and the current economic and financial crisis seems to be brewing future strife. Our current rulers have managed to dispense enough mortgage debt and football entertainment (“panem et circenses”) over recent years to keep the populace quiet, but as defaults soar incentives will change....and they call this a democracy.

From the fire into the frying pan

As I reflect on the course of action that governments around the world have taken in addressing the current financial crisis, I realise that there is something profoundly disturbing in these actions. If the underlying problem is an investment bubble financed by savings which have been invested into projects that are based on wildly unrealistic expectations, then shifting these inflated assets from the balance sheets of the private sector to the balance sheet of the public sector is not going to solve anything. It will buy time for a short period until investors realise that the underlying premises which supported the valuation of these assets are still as wildly unrealistic as they were before, only now a government guarantee has been slapped on. Governments, however, will still have to pay for the bill... and how will they do that? As little, if any cash will be forthcoming from these investments, my hypothesis is that they will either: (i) eventually raise taxes or (ii) print money which will lead to inflation (another form of tax). As a consequence, the losses will have been transferred from those who held the risk of these inflated assets to society at large.

Losses, like the previous 15 years of profit, should accrue to those that took the risk in investing in these assets. Share and debtholders in financial intermediaries should be wiped out where appropriate, shareholders in general should also suffer from the new revised valuations, and real estate should similarly adjust (these are, after all, risky assets). The necessary wealth destruction and consequent deleveraging should take place, fast. I suspect, further, that bearing these losses will not lead to serious social unrest as most of these investors have alternative sources of wealth. The only part of the financial system that, in my opinion, merits government intervention is the payments system and commercial bank accounts. Another possible alternative, if the level of uncertainty is such that a liquidity freeze sets in, could be for the government to set a floor at, say 25-30%, of peak prices in certain markets. It is highly unlikely that this level would ever be reached but it would provide support and comfort to an unstable market.

On the economic side, I concur with the idea that governments use their borrowing capacity to undertake investment projects which can have an effect on productivity; primarily infrastructure investments . These projects can act as a cushion on reductions in aggregate demand, temporarily alleviate unemployment and promote future competitiveness. Eventually, however, reality must kick in and economic players (capital and labour) will have to adjust to lower returns, or, better still, a new productivity model will have to be found. If the right incentives are provided, I have no doubt as to mankind’s ability to develop another groundbreaking development. Just think how much the world has changed (positively) in the last 100 years.

Bailing out the bozos

So the great unwinding is finally happening...the time has come for the prudent and responsible to emerge from obscurity; or maybe not? As put by one reader of the FT Alphaville section (http://ftalphaville.ft.com/blog/2008/11/19/18402/bailout-me/): “So I’ve cautiously decided to keep my cash on deposit in the bank - taxed at 40%, not only do I have to put up with falling interest rates and a depreciating currency but as a tax payer I will be bailing out all the people who told me: ‘You are an idiot, because what you don’t understand is that house prices only ever go up’”

Precisely. Why should the cautious now help to subsidise the fast cars and expensive holidays that certain individuals purchased with debt secured on inflated assets? Many borrowed money and overspent without regard to prudence; thus implicitly forgoing future consumption. It’s now time for these individuals to save and repay their debts. If they can’t repay with current income, then they should lower their living standards and/or liquidate their assets. However, government action across the world seems bent on bailing out these poor souls by paying their debt with other people’s money. In other words, a policy of “the gain is individual while the pain is socialised” has now been institutionalised.

Another mistake. If individuals are spared from the consequences of self-inflicted actions, the necessary learning process will not take place. Lessons must be learnt for mistakes to be avoided in the future. True, there might be grievous instances of injustice which can and should be covered by a safety net, but these represent a small minority.

Similarly, companies and their senior management have to pay for past mistakes. I remember advising corporate CFOs to lock-in long term committed facilities to finance long term assets, yet many refused because this implied a higher cost in commitment fees. Those that took such advice are sitting pretty while the ones who didn’t are now clamouring for government rescue packages. I don’t think the latter will be returning their 2003-2007 bonuses anytime soon. Why should taxpayers then shoulder the consequences of their bad management? I take the point that systemic risk should be avoided, but companies that access public funding should, as a condition precedent, remove all the top management which led them into the situation in the first place. Only then will the lessons be learnt.

The chickens have roosted...

Well, it has been some time since I updated this blog and many of the things that were predicted have finally occurred. However, the speed of it all has certainly been surprising. When I wrote some months ago that the virtuous circle which had fed global growth in the last few years could easily turn into a vicious one, I had no idea of the scale of this viciousness. The extent to which wealth has been destroyed is vast- pity those poor pensioners in defined contribution systems! Today, Bear Stearns, Lehman, Merrill, AIG, Fortis, Dexia, Hypo Real Estate, Washington Mutual, Wachovia, Alliance & Leicester, Bardford & Bingley, Morgan Stanley and Goldman Sachs have either disappeared or been transformed. Expect more consolidation.

Some commentators argue that there has been a complete “market failure”; I would argue exactly the opposite. There has been a clear and blatant “failure of regulation”, especially in the US, where politicians have interfered with the Federal Reserve and Government Sponsored Entities in order to pursue a lax monetary policy which would statistically noteworthy but unsustainable GDP growth data and, ultimately, votes. One only has to review past press articles on FNMA and FNMC to note how politicians took measures so that these institutions would provide access to credit to all segments of the population; including those who, it turns out, were not creditworthy.

In those jurisdictions where central bankers, in their supervisory role, were really independent, the scale of the shock has been much smaller. In Spain, for example, the central bank did not allow local players to use off balance-sheet SPVs to fund credit in order to engage in capital and liquidity arbitrage. Why? Because it was pretty obvious that this was exactly what these vehicles were engaged in. The creation of a parallel banking system was not permitted. As a result, Spanish banks have serious credit issues arising from their real estate portfolio but they have not experienced the pain of some of their foreign brethren. Some cajas or mutual savings banks, however, given their limited ability to raise capital and, in some instances, political interference, are likely to fare much worse than the banks.

Other commentators have mentioned diminishing competition as a concern, given the level of concentration in some markets- in my opinion, this is a minor issue. Sure, the UK clearers are consolidating but note that one of the consolidators is Spanish. It’s really about time that European countries got their act together and encouraged cross-border mergers. I would hazard that we will see more of these in the coming 5-10 years and eventually see a pan-European competitive arena.

Ultimately, however, there is still impending doom in the form of inflation. Globalisation has allowed developed economies to import deflation from low cost countries while pursuing an expansive monetary policy, but now that emerging markets are exporting inflation, it is only a question of time before it feeds into developed markets. I can only imagine that an expansive monetary policy combined with rising inflation will have serious implications on the value of money. Most people remember the 1929 US stock market crash as the aftermath of the Roaring 20s, but events in the Weimar Republic had an even more significant impact. Let’s hope we don’t end up like Germany in the 30s.

And on that happy note, hope you are all having a swimmingly good time...

If it's free, it's not valued...

At a recent dinner, a dear friend explained to me that his views on economics were liberal (in the English sense) but that he viewed the US healthcare system as a failure in that it did not provide universal access to healthcare! The US Medicare and Medicaid programmes do provide coverage but only for retirees and people below the poverty line. He then went to defend the Canadian and Continental European systems as examples of well-run healthcare systems.

As usual, defenders of tax-funded universal healthcare demonstrate a basic misunderstanding of economics (he is a journalist). They view healthcare as a "right" instead of what it is...a transaction which is subject to the same economic forces as any other (supply and demand!). As a consequence, any service which is free or supplied at less than cost tends to lead to shortages and rationing. Both the Canadian and Continental European systems demonstrate such trends in the form of waiting lists. Hence, a patient who requires surgery has to wait for critical weeks to obtain surgery; weeks during which illness progresses and often leads to terminal conditions. It is not suprising, therefore, that many Canadians often cross the border to the US to obtain healthcare rather than be subject to potentially fatal waiting lists.

In Spain, the previous government tried to introduce a one-euro fee for visits to consultants and then rapidly withdrew its proposal after social outrage. One only has to visit a public hospital to witness the queues of patients lining up for imaginary illnesses. Many retirees often visit their consultants once a week- if it's free, why not? Like other "free goods", demand is virtually unlimited, while supply is only forthcoming at the price where it mobilises resources. Witness the recent shortage of water in Barcelona as an example. No doubt my friend would defend that water is also a "right"...which is why there are shortages. After all, someone has to pay for a supplier to offer it. There are numerous studies which show that demand for healthcare falls dramatically when a price signal is attached to it, without any impact on the overall healthcare of users. Thus, catastrophic healthcare insurance (which would cover expenses from USD 2500 onwards, say) would save governments inmeasurable resources to spend on other more useful matters (how about improving productivity?).

The problem with the "catastrophic coverage" system is that, in most countries (including the US), healthcare insurance can be provided by companies as a non-taxable payment in kind to employees. As a result, employees often choose coverage with a lower deductible, given the tax benefit (subsidy) obtained; which leads to higher demand for healthcare as well as higher (pre-tax) premiums. Thus, when a person loses his/her job, the cost of maintaining former insurance (without the tax benefit) can be prohibitive. However, the cost of catastrophic coverage is reasonable (e.g. USD 29/month with a USD 250 euro deductible and capped at USD 1 million for a 30yr old non-smoking female).

Tax-funded healthcare systems, therefore, tend to lead to lower quality and higher cost delivery of healthcare. It also leads to disincentives to care for one's health (why should I stop smoking or eating fatty foods if the consequences are paid by everyone). In my opinion, compulsory catastrophic insurance combined with voluntary supplementary care would lead to a more efficient allocation of resources. If it's free, it's not valued...

Ministry of Stupidity

If it wasn’t tragic, I would think it was comic. Mr. Rodriguez (a.k.a. “Zapatero”) has decided that Spaniards require further ministerial indoctrination. We have recently been blessed with a brand new Ministry for Equality.Its role is not very clear but that is beyond the point...the fact is that we now have another chauffeur-driven, budget-wielding, incompetent politician with no significant track record of any sort beyond many years of carefree expenditure of taxpayers’ euros. The fortunate recipient of this taxpayers’ largesse is a young woman by the name of Bibiana Aído. She is only 31 years old but has already profited from many years of public larceny. Before her designation she was the “Director for the Andalucian Agency for the Development of Flamenco of the Council for Culture of the Andalusian Regional Government”, where she spent almost three meaningful and productive years. She was recently acknowledged in the press for singing the praises of Mr. Rodríguez during the recent election campaign: “Oh, Jose Luis, smile! You have a clean smile that favours you so much”. Anyway, enough said about this aspiring looter: maybe I do bear some grudge for not having achieved chauffeur-driven status after many years of work.

Let’s move on to the mission that Ms. Aído has been charged with. Ministry of Equality...hmmm. I suppose “Equality” is a concept that no-one can object to, at least on initial reflection. I suspect, however, that Mr. Rodriguez and I disagree as to what we mean by equality. As a good socialist, Mr Rodriguez and his young henchwoman Ms Aído defend equality as an enforced concept. We must all be equal: but equal to what or to whom? No doubt that Mr Rodriguez and his fan club already have a view as to their ideal “equal”. It is probably not dissimilar to the “equal” that Stalin and Hitler portrayed in their propaganda. The new socialist “super-person” of the 21st Century that we must all aspire to be. Therefore they are sure to legislate that we are must all be or act “equal”...the choice to be different, to be independent, to have free will, has to be eliminated. This socialist concept is based on the false premise that either we are all equal or that we aspire to be equal. In fact, I have news for you...we are not and we do not (at least I don’t). People have different abilities and aspirations based on genetic and environmental factors: some of us are better suited at some things than others and we have to match our aspirations to these- I would love to run 100m in less than 10secs or get a Pritzker Price in archictecture but neither speed nor technical drawing are my fortes. To legislate specifically for equality is the same as to legislate for the sun’s disappearance- idiotic and doomed to failure.

The definition of equality that I relate to is associated with the availability of opportunities/choice for all via the creation of an enviroment which encourages the elimination of entrenched privilege of all types; ie. the establishment of a society where each person can pursue their individual aspirations according to their desires and abilities, based on a minimum framework of laws. I don’t think we need a Ministry for Equality for that; in fact I don’t think we need any more ministries, thank you.

The "originate to default model" and its unsavoury characters

I’ve spent enough time in banks and a brief but intense stint during Enron’s twilight to understand the huge unravelling of the farce cum accident-waiting–to-happen of the current banking crisis. Commercial banking has always been regarded as the backwater of financial services until some bright investment bankers decided that they were going to turn a traditional and sleepy banking model into a money-making machine.

Historically, commercial bankers had a deep and ingrained sense of credit risk derived from the knowledge that they were investing other people’s money; usually deposits. As a result, loans were carefully monitored and handed out cautiously. Leverage was treated as a dangerous and addictive treatment and, as such, was to be administered sparingly. Assets were booked on the balance sheet and kept to maturity. If a loan went bad, the banker was undoubtedly affected. That is, until the “i- bankers” arrived and decided that through the use of debt capital markets, financial institutions could offload this exposure to unsuspecting investors. Thus the “originate to distribute” model was born...

The new operating model consisted in hiring aggressive, young and naïve bankers (akin to sales reps) whose sole role was to push money out of the door. This role was supported by a clique of product specialist whose letimotif was to distribute the rubbish that was originated to unsuspecting investors. These product specialists came in different flavours: one was the syndication specialist who usually onsold the rubbish to less sophisticated banking institutions and the other was the debt capital markets specialist who created securities backed by rubbish as collateral. Both systems created moral hazard by decoupling the credit risk from its associated rewards. Banks found they could engage in almost risk-free lending.

The process described above created a “virtuous” circle in which extremes soon started to flourish. Originators became more naïve, loan documentation became weaker, credit spreads fell lower and the borrower held all the negotiating power. The approach across banks was: “Who cares? We’re not keeping this crap anyway...” Meanwhile, borrowers had a field day, low income households went on a spending spree supported by debt secured on credit-bubble inflated assets, private equity firms added “value” through leverage, the financial services sector had a field day... and in ten years the “originate to distribute” model mutated into the “originate to default” model. Now that the loans have been originated the time has arrived for them to default. Who’s first in line? (i) Countries: Spain, USA, UK, Ireland and China as the big beneficiary of spending but also a major creditor; (ii) Sectors: Real Estate, Automobile, Infrastructure, Financial Services and any sector depending on high leverage or cheap financing.

Who are the industry characters that have flourished in this environment? I could name a few but I am sure it is not necessary. If you are in the business you will recognise them. Ego-driven, mediocre, social psychopaths, good communicators, with an unrelentless focus on short-term earnings and a lack of ethical or moral standards to constrain them; fuelled by compensation mechanisms which reward today’s income but do not penalise for disaster tomorrow. The new “masters of the universe” seem in hindsight to have been “the masters of disaster”.. Few people, including myself I’m afraid, had the courage to stand up to these bullies while the going was good. It’s high time they were let go...

For an interesting read try: http://www.ft.com/cms/s/0/d3321cc4-ffef-11dc-825a-000077b07658.html

My vote in defense of freedom

It has taken me almost a week to recover from the depression brought on by watching the candidates of the two largest Spanish parties debating on TV. A succession of vacuous economic data, accusations, and tirades was matched by an almost complete lack of concrete proposals and illustrations as to what each candidate really represented. My conclusion after the debate was that it didn’t really matter who won- it was going to be the same animal with a different fur. It also reaffirmed my belief that government needs to be small. The smaller it is the less chance these people have of screwing things up.

I would have expected a debate between two candidates defending two radically opposed views of the world. The first, inherited from Marxist beliefs which holds an ideologically appealing but empirically impractical view of the world, and a second, defending freedom of the individual to manage his life in a way he thinks fit, devoid of constraints imposed by a few who claim to interpret the will of the many. I support the latter view, not because I think it is the best political system in the theoretical vacuum of a political sciences faculty, but because my experience has led me to believe that it is the better system in an imperfect world.

My views also stem from a deep desire to avoid being told what to do by an empty, all encompassing entity which needs to constantly limit individual liberty to feed itself, in a perverse vicious circle. I detest the concept of Big Brother depicted in Orwell’s 1984 novel. However, I can understand and respect naiveté and gullibility. This is why so many students are interventionists- they are young and have limited practical experience thus defending ideologies which are appealing in theory but impossible in practice.

But, I abhorr hipocrisy. The sight of an experienced politician defending the collective good when the ultimate aim is to defend his individual well-being is enough to make me choke. I almost collapsed when a succession of so-called artists recently decided to defend the political option which is more likely to maintain a system which consists in taxing the whole of society so that a few bureaucrats with exhibionist leanings can pose on the photo shoots of the yellow press in exchange for generous dollops of public money. Who is this gauche caviar with Swiss bank accounts and mansions in exclusive neighbourhoods to demand my vote? I work hard in a company which sells products in transactions which are uncoerced and unsubsidised. Why use my hard-earned tax euros to give them to the friend of whichever politician happens to be in the Ministry of “Culture” so that they can make films that nobody wants to see? I’ll use my hard-earned money to see films that I want to see- thank you very much.

There is a huge irony in that precisely the people who have benefitted from liberalism are now crying foul and asking for more interventionism. A major part of the reason why they have done so well in the world is that the last few decades have involved a scaleback in intervention and now they want to go back? The collapse of Communism and the resulting positive impact on so many people’s wellbeing should really have demonstrated this. I would suggest that interventionists (be they left or right) spend some time living in countries like Myanmar, Cuba or Venezuela to get a real taste of what the practical execution of utopian ideals leads to.

So; after the above tirade, who am I going to vote for? I will place a forlorn and hesitant ballot with Partido Popular’s name inside the box. Why? Basically because it is the lesser of the available evils. The few people who are truly libertarian and believe in individual rights and freedom can be found in the Partido Popular. Yes, the are completely outnumbered and outmanoeouvred by the conservative interventionists but it is the only party where some of its members have ideas which resemble mine. Hopefully, one day, their voice will be heard.

From stock to flow- the Enron story repeated

I have a sense of deja-vu. In early 2001, I joined Enron Broadband Services only to leave after a couple of months, shocked at a company culture that had an unhealthy focus on accounting earnings above any other consideration. Three months after my resignation, the company filed for bankruptcy in the largest case of its kind in history. Essentially, the company had booked uncertain future earnings upfront through the use of clever accounting structures, which kept the debt-fuelled growth off-balance sheet. When the uncertainty turned into reality, the whole structure unwound in record time.

Today, it is happening all over again, in what the press have incorrectly dubbed the "sub-prime crisis". Sub-prime loans are only the tip of the iceberg in a business (financial intermediation) that has changed dramatically in the last 15 years. I have been employed in the financial services industry for that time and have been intimately involved in many aspects of that change.

When I started in banking in the early 1990s, the business was all about prudent use of funds which were primarily backed by depositors and a capital base. The philosophy underlying lending was that "we were handling other people's money" and, as such, we had a fiduciary duty to depositors. In addition, any losses would first hit the limited capital base of the bank. Annual profits were predictable, since the prevalent accounting systems would ensure that returns would accrue over time, as the loan portfolio amortised over time. Given capital constraints, new lending was limited to available capacity, which freed up as the loan book matured. In summary, banking was a solid, stable and conservative business in regulated environment (much as Enron's gas pipeline business had once represented).

In the early 1990s, the concept of securitisation was developed. In essence, this entailed the repackaging of loans from bank balance sheets and their subsequent so called "true sale" to investors in exchange for an origination fee, which was booked upfront. Appetite for these securities was supported by institutional investors' demand for fixed income assets, themselves fuelled by favourable economic conditions and the growth of private pension systems. Initially, this business was a small niche which allowed banks to selectively originate loans beyond what their capital base would allow. It also meant that the profit made on a portfolio of loans could be booked upfront on its sale, instead of accruing over time while it matured in the banks' balance sheet.

The traders and investment bankers in banks realised that by changing the banking business from "stock to flow", much larger origination volumes could be underwritten and offloaded ("distributed" in the industry jargon) to investors via securitisation and syndication of loans. Furthermore, and, in order to address investor bases concerned with long tenors and liquidity, special vehicles were created which would issue short term commercial paper to fund long term paper. When traditional investors found themselves full of this asset-backed paper, banks would encourage more aggressive investors (such as hedge funds) by lending them money to buy the instruments they had originated. Huge profits were made as revenues were booked upfront, but the stability of earnings once provided by accrual accounting was foresaken.

As a result, bankers in the late 90s and early 00s were incentivised to focus exclusively on loan quantity and not quality. The mantra over the last couple of years in front office areas has been to originate, originate and originate. Damn credit quality- loans would be offloaded anyway.

Gradually, banks' balance sheets started to accumulate loan inventory that was designed to be temporarily warehoused in anticipation of future sales to investors, as well as loans to investors who would themselves buy the offloaded paper. Also, off-balance sheet liquidity commitments were provided to commercial paper vehicles to guarantee to investors that liquidity would be forthcoming, in the "highly unlikely case of a liquidity crisis occurring". Of course, as these commitments grew, so did the likelihood of such an event occurring.

Then came the summer of 2007. Investors realised that the quality of the underlying loans had become so poor ("ninja loans" or loans to borrowers with no job, no income, and no assets being just one example) that no amount of financial structuring could compensate. Also, asset prices (primarily property) fuelled by this indiscriminate lending had stopped rising. Investors stopped buying new securities and renewing commercial paper, and the "virtuous circle" created by the move from stock to flow turned into a vicious circle.

Banks suddenly found they could no longer sell what they originated. Furthermore, they were stuck with inventory whose poor credit quality they were only too aware of. Market prices plummetted. Their inmediate reaction was to hoard cash in anticipation of future credit problems and obligations to fulfill liquidity commitments provided to commercial paper vehicles.

The consequences thus far have been twofold: first, a liquidity crisis has ensued as banks are forced to fund special purpose vehicles at a time when the interbank market has dried up, and; second, an asset credit quality debacle has occurred as banks are stuck with loan inventory of poor credit quality that they never intended to keep in their balance sheet.

However, this crisis will have longer term consequences. The stock to flow model has been questioned and future profits are likely to be lower than recent ones. Sub-prime loans are only the first in a pyramid of loans that have been granted with little or no regard to willingness or ability to pay. Credit cards, car loans, LBOs and other leveraged loans are likely to come next. The almost limitless and reckless lending which we have seen and which has fuelled much of recent economic growth will dramatically slow down.

A moment of reflection here. Note that poor quality assets are still in the system beyond those reflected in banks, mainly in pension funds, insurance companies, mutual funds and other unsuspecting investors who are investing savings of the general public. Once the music in the game of musical chairs stopped (to paraphrase Citigroup's haplesss former chairman Chuck Prince), the whole house of cards started to collapse.

So, we find ourselves in a position similar to the one experienced in the Enron debacle, except on a systemic scale. Fomer accounting and rewards systems designed to make a sensitive and strategic industry conservative are replaced by a system which incentivises speculation and risk- from stock to flow or from caution to greed.

Orwellian Regionalism in Catalonia

I have just moved to Barcelona, in Catalonia. I love it here- the weather is great, as are the food and the people. However, something is not quite right. One of the first things that struck me, as a non-Catalan, is the amount of energy spent in proving that Catalans are different. Different from what? Different from the rest of Spain, primarily. It is almost as if Catalans (or a certain sub-set) define themselves by exclusion, i.e. by what they are not, instead of what they are.


As a consequence, in a great number of the social events that I have attended, the issue of Catalonian politics has come up as a major discussion topic. Inevitably, the conversation starts by someone asking me how I have settled in and is then followed by long tirades explaining why my perceptions are manifestly incorrect. This is something that I have not experienced in other discussions, with the exception of the Israeli-Palestinian conflict where one or the other affected party was involved.


I think that a certain part of Catalan society relies on a sense of grievance (real or perceived) to justify a series of actions that would not be reasonable under normal circumstances. Given this "persecution", legislators feel compelled to enact discriminatory legislation which limits personal freedom or eschews meritocracy by valuing nationalist credentials above any other criteria. As a result, regional governments spend a substantial part of their budget in working against central government initiatives instead of cooperating with them. Witness the creation of Catalan cultural institutes, development banks, sports federations, foundations and other "duplicated institutions" which lead to a shameful waste of resources. Given the pervasiveness of regional government intervention, the emphasis on knowledge of the local language above other technical criteria is leading to a society of poor technicians with strong language skills.


In my opinion, the current political situation reflects poorly on a region of Spain that was known for its common sense, its love of freedom, and a flourishing entrepreneurial class. The bureaucrats must learn to encourage personal and economic freedom by using their resources to do just that instead of attempting to duplicate what the central government is doing. One of the competitive advantages of Catalonia is that it is probably the most attractive region in a country of 44 million people and a focus on the similarities as opposed to the differences would undoubtedly lead to a more competitive approach to the challenges posed by globalisation.


Mind you, this is not an exclusive problem of Catalonia. The excessive decentralisation of the Spanish government has led to some autonomous regions depending almost exclusively on regional governments for economic development. Andalusia is a well-known example. Catalonia is heading the way of Andalusia by depending more and more on government hand-outs and less on private initiative. The irony of this state of affairs is that twenty years ago the aspiration of many poorer regions such as Andalusia was to converge with Catalonia...today it seems as if Catalonia wants to converge with Andalusia.

Immigration? Yes! But Let's Be Smart About It

One of the social and economic issues facing Spanish society today is that we like to enjoy ourselves...maybe too much. We are not having enough children to replace populations in our societies. On the other hand, we also live in a society where there is relative economic and political freedom, and, as a result, there has been a tendency to "import" people from more populous countries who come to our own looking for the economic freedom which they lack.

However, I believe that Spain and many other developed countries are going the wrong way around this problem, and, through flawed immigration policies, are importing not only people, but also the social problems from their countries of origin.

In Spain, for example, most immigrants are unskilled workers who come to do jobs that Spaniards will not do at the price that Spanish entrepreneurs are willing to pay, mostly in the services industry. What does that mean?

In my opinion, all this means is that Spanish entrepreneurs have found a class of worker who is willing to work for a wage that Spaniards will not work for, though there are plenty of available Spanish workers. Immigrants work longer hours, have less social benefits, and pose less problems than a "first world worker". The argument in favour of this state of affairs goes that if we did not engage in importing unskilled workers surely Spain would suffer given competition from lower wage countries.

This argument is manifestly flawed. The industries that cheap unskilled workers are involved in are eminently non-tradable, primarily construction and tourism. You cannot trade a coffee in a bar in Majorca or a block of flats in the coast of Spain with China. Therefore, the benefit of cheap labour accrues mainly to the entrepreneur...notice the boom in wealth derived from residential construction and the service industry in Spain.

On the other hand, Spanish society has to bear the costs implicit in paying people a wage which is below what local or European citizens would work for. Remember we are talking about unskilled workers from emerging markets. In general this are people with little education, few democratic or liberal values, fundamentalist religious beliefs, no family connections in their host countries and, in many cases, imported health burdens. These costs have to be borne by Spanish and European welfare systems. Take a walk around a public hospital or school if you don't believe me...

So, first message: when we import unskilled workers to serve in non-tradable sectors of the economy, we are also importing the social problems of their countries of origin. The benefits accrue to the entrepreneurs in these sectors while the costs are spread across society.

At the same time, however, it is incredibly difficult for skilled workers to obtain legal permits to work in Spain. I read a case in Expansion newspaper two days ago of two Japanese biotech researchers who, in view of the long delay in obtaining their visas, and under encouragement from the Spanish subsidiary of a Japanese company, worked in Spain under a tourist visa, only for them to be fined by the tax authorities for fraud. They eventually got their visas, ten months after the request, and some months after they had returned to Japan. This type of immigration benefits tradable sectors of the Spanish economy and society as a whole, yet because these immigrants traditionally respect immigration laws, they often find it next to impossible to come and work in Spain.

To conclude, unskilled workers are coming in droves, ignoring the legal requirements to work in the country and importing their social problems while benefitting a minority of the Spanish population. On the other hand, skilled workers, who usually respect the legal requirements to work, find it increasingly hard to work in Spain where they would work in tradable sectors which would benefit Spanish society as a whole.

Are we mad or what?

Raise Your Hand If You Think Inflation Is Dead

Yes, the chickens are really coming home to roost. Yet there is one chicken we have not heard much from lately and her name is "Inflation".

Official statisticians would have us believe that inflation, as measured by CPI, has been under control for many years, but you only have to notice a few tell-tale signs to predict that it is paving a way for a glorious re-entrée.

One of the strongest points in favour of globalisation was that it permitted the export of disinflation from low production cost countries to high production cost countries. The latter's governments have been extremely quick to take advantage of this by hitting the print button on the money machine faster than ever. Under normal circumstances "too much money chasing too few goods" would lead to an increase in the price of the latter. However, with China and India making many of those goods, the inflationary impact of an expansive monetary policy has been offset by lower production costs. Many consumer goods have experienced little inflation over the last 10 years or so.

But what about non-tradable or non-traded goods, such as real estate and local services- restaurants, housekeeping, and some agricultural products. Have they followed the same path? My hypothesis is that they have not and, in fact, asset price inflation has been on the rampage, only mitigated by the expansive monetary policy (i.e. low interest rates) which has made financing these assets historically cheap.

Thus, you have a combination of cheap consumer goods and expensive non tradable assets financed by cheap debt. It is obvious that such a combination cannot be sustained indefinitely and there are signs that the "times they are a changin' ". Disinflation from China and India seems to have run most of its course. There are limited productivity gains and increased wage pressures in both countries which will eventually lead to inflation. The maxim of "everything that China buys will go up and everything that China sells will go down" cannot hold for much longer.

The boys and girls in the central banks are not doing their job either. Faced with irate politicians that are scared of bursting the bubble, they have not increased interest rates enough and are, in fact, lowering rates as we speak. After all, inflation is a tax that is borne by many and therefore attributable to indefinite and nebulous causes. Bubbles bursting are sharp and painful and the victims loud and influential. Try guessing what the politicians choice will be.

I recommend the following article by Spanish professor Trías de Bea- a genuine gem:

http://img219.imageshack.us/img219/1134/triasdebescopiahb4.jpg

My prediction is that tight trousers with bellbottoms and over-size collar shirts are back. Yes, dust off those wide ties and lacy shirts- the 1970s with their glorious stagflation will soon be back in vogue.

Ladies, gentlemen...prepare for landing.