MY BONUS IS YOUR BONUS TOO!

In line with public anger, Government and regulator sentiments, I wish to advise all my clients that I voluntarily accept a zero bonus remuneration cap for 2009 and 2010. Contractually binding arrangements with my various service companies, onshore and offshore, and unearned income streams from my various % of our portfolios remain as before. New York State Comptroller Thomas P. DiNapoli estimates that the US securities industry granted its employees $18.4 billions in bonuses in 2008 – a revelation that President Barack Obama characterizes as “shameful". I agree with him, this is very poor show. However, actual payout is much higher than this surely? $18.4 billion is only the cash portion of the bonus payouts and only accounted for the money paid to securities-industry employees who worked in NYC. Bonuses paid to such as myself working outside the city aren’t included. The Comptroller’s estimates don't include stock options not yet exercised, worth about another 25-100% of the cash bonus. Wall Street’s appetites for high rewards are said to have precipitated the banking-credit crisis, requiring taxpayers to pay our bills. and I don't charge any fees for photo opportunities or other busines smeetings and parties in the city. In future my bonuses will come from advising how taxpayers too may enjoy financial profits by packaging and selling assets at mouth-watering discounts to the Treasury and Federal Reserve, and this is what I've been telling little and big investor people at every opportunity. Currently, it is supposed that those same taxpayers are being asked to finance Wall Street’s bonus payouts, which were actually a proximate cause of the crisis. Not so. Tax liabilities for buying toxic bank assets generating substantial coupon may be deferred over a 20 year period! In fact, we are busy collecting tax liabilities right now, packaging these up and selling them at private auction. Thus, just as we distributed risk, we are now distributing the bonus rewards too and I feel sure that my remuneration (performance-related) will be commiserate. Life is a matter of incentives whether for actions that led to the near-collapse of the U.S. banking system or better for actions that lead to its miraculous recovery. This is just bio-economics, the fundamental greed, deceit and indifference of Adam Smith's "invisible hand" lending another "invisible hand" to redeeming the travesty of a mockery of a sham, shameful, irresponsible, hubris and so on being turned to greater advantage for all. Understanding the social dimension of the compensation equation requires a qualitative look at more than just the numbers. And for this our latest algorithmic models and techniques are the best in the business.
To all my employees I say, yes, proxy season is fast-approaching: the time of year when public companies – ahead of AGMs – send out proxy statements for shareholder resolutions and senior-exec compensation, but not in the same post please as interim trading statements, and when my institutional poker school friends collect your proxy votes to back each of my Board resolutions for the forseeable future measured by proxy asymptotic single factor economic risk indicators, red, amber, or green proxy-wise. The media paparazzi will attempt to photograph you by your new pool or at downtown champagne parties, on yachts in the Med and so on - it is the start of the shooting season on bonus execs, long eye-watering stories about huge payouts in cash, shares or other trinkets (all merely relative of course), quite forgetting that we pay tax at source, unless offshore (or non-cash in kind as in my companies' bonus barter timeshare system), or postponed bonuses and grants of stock numbered options under treasury SNOUT and structured complex original option plans, SCOOP.
This year, however, due to the ongoing financial restructuring crisis (plight for some, opportunity for others), exec-pay has become elevated to a most heightened emotional level (including by private plane, helicopter, boat, tourist property, clubs, restaurants, private schools, charities and luxury goods companies). Some firms taking government bail money have paid big bonuses (what in our group we now call arrangement & legal fees, independent valuation studies, due diligence costs etc. without attracting the ire of Federal legislators and the U.S. President's administration). Just so my employees understand why we're capping cash at $0.5m each, yesterday President Obama announced a salary cap of $500,000 for top execs (in firms participating in federal bailout programs) as an expression of fairness and “basic common sense.” Note: For 10 years, the NY State Comptroller’s office estimated bonuses paid to NYC-based securities industry employees. Last year's $18.4 bn is a 44% down from the $32.9 bn in 2007. But, that ain’t quite so steep as our Wall Street friends fear. We cut payrolls by 19,200, roughly 10.2% off the 2007 level of 187,800, so today's average bonus of $112,000 is now dispersed over fewer, a drop of only 36% (ave. cash bonus in 2007 was $175,186). Of course, not all of you gets a bonus and some folks get only small ones for now. Our clerks making $35,000 a year gross ain't getting $112,000, nosirree; but if you get to be a trader on say $150,000 gross, hey there's $2 m in your bonus pot (before tax) and you sure better be worth it! This here is a profit-driven industry, what goes to our traders comes straight outta my and my partners' share, and our shareholders and bondholders and the IRS and so on too of course! It’s important to remember all that, that while all are paid enough for the basics of living and commuting, bonuses are what you really work for as bankers, stock traders, money brokers and bond managers. To those of you who've been fired and not rehired, y'all can kiss that goodbye. Top salaries hereabouts are $100,000 to $750,000, but most are in the low-six-figure column of our IRS spreadsheet. In my case I am not salaried, of course, therefore all such restrictions and equations do not apply.
Our peer-group comparisons: end of last year, top guys at Goldmans decided to forgo any cash, stock or options bonuses for 2008, “the right thing to do” and I applaud their reinvestment of these for the future when valuations are near bottom. The top execs make do with $600,000 salaries aside from 'unearned incomes'. As for lower employees, they get a bonus pool of $2.6bn. But none of the $25bn of TARP money GS received will go to bonuses directly, not now, all sensibly reinvested. There is a nobility about forgoing bonus compensation on top of a $0.6m salary before tax. To understand the nobility of this, in 2007 CEO Lloyd C. Blankfein was worth $68.5m; co-presidents Jon Winkelried and Gary D. Cohn $67.5m; and David A. Viniar, CFO, $57.5m, all before tax. Politics: President Obama calls the $18.4 bn bonus pool “shameful,” U.S. Sen. Claire McCaskill, D-MO (pictured above in the pink), says that we "[just] don’t get it. These people are idiots.” I beg to differ here. This is a great time to be investing and not focusing on current income, not when returns to cash are paltry. Such funds are far better left in the business medium term to earn bigger returns later. McCaskill cites that execs at 116 banks that got government funds were paid an average of $2.6m in bonuses and 700 at Merrils got $1m or more. How can she say we're all idiots to be doing so well?
Responsible budgeting: Citigroup Inc. has reconsidered a $50m corporate jet in the context of $45bn Federal funds plus $300bn in government insurance received against losses on toxics. Obviously $50m is chump change in bigger picture. Citi cancelled delivery of the jet, because of pressure from U.S. Treasury Dept. What business is it of Treasury to worry about minor PR like this? Anyways, lease-back is an option in order not to damage the aerospace manufacturing sector at this critical time, and to help Citi out we may do the deal for them as a soft commission fee for which we'll chuck in our OBAMA remuneration risk metrics system for free.
McCaskill is vocalizing her voters' anger and has sponsored a bill called the Cap Executive Officer Pay Act CEOPA, so that any bail money recipients are capped at $400k, 25% less than President Obama is willing to grant. She picked $400k because that’s the salary paid to the President Obama, or 8 times median U.S. household income – which may not seem too bad, except for my pal Goldman’s Blankfein . who made that every 2 days back in the good days. A fuller accounting might include office costs, travel and other incidentals, and then I guess the Obama ratio measure would go up, like a whole lot. Sen. McCaskill doesn’t want to take away our toys or the 'punchbowl' entirely; she says once taxpayers get back what we owe them, we are free to pay whatever. The US Treasury’s TARP requires that senior-exec compensation is subject to “clawbacks” if compensation is based on inaccurate algorithms, where our new product comes in bigtime, the OBAMA (Opaque Bonus Assessment Management Algorithm). There's no color bar here as my pal Stan will confirm. For all our execs who artfully insist on severances and golden parachute contracts after bailing out or being pushed out of whatever they helped wreck, there’s no such provision envisaged in our proxies and next published accounts. I'm mindful of the plight of nice guy pal Merrill Lynch CEO “Stan” O’Neal, who got retired after announcing losses of $8bn (later revised to over $27bn, by the end of '08). He had to take a pay deal of $161m. But I told him, "Stan, with out OBAMA calc you can get a Bank of America pension fund bonus due on the tax saving over the 20 year period this loss is recoverable from the IRS. This shows just how effective our OBAMA bonus culture is when re-structured for "long term sustainable performance" measures.
My other close friends such as Citigroup boss Chuck Prince, who left with a $38m so-called “bonus” after announcing $billions in losses and steering the bank close to but not into near technical-insolvency, he took our advice in at least highlighting $500bn of book value potential sales when we showed how this may now be written down by say $150bn and become a valuable long term profitable tax liability vehicle subject to a series of complex related business programs of sell-offs and rehirings financed out of a 20 year MTN program. Or too, Martin Sullivan, former CEO of AIG, a great guy with a massive pool in his basement I paid for, when AIG won $85bn in cash and another $45bn in insurance backstops. For this he got $39.6m in his last 3 years and so this needed topping up using our OBAMA model with a useful additional $47m, that my boys figured out to be $15m severance, $4m bonus proportionate to the days he actually worked (at the office), plus stock and long-term cash worth about $28m. It is people like us who are the makers of money, the 'invisible hand' that according to the Scottish Saint of the matter of how to make it, Adam Smith, indirectly benefits everyone. This is something the cartoonists will never understand and of course I have to laugh too. In the final analysis, as my friends ask themselves fearlessly, are we worth what we are paid. Sure. Well, clearly given the risk/reward scale at which we take big decisions, would it be safe to pay us any less? And we know that now we are going to be making money for taxpayers too and that means bigger benefits all round! As I said at the last Algonquin Club gettogether “We want the smartest folks running these firms and in order to get them you have to compensate them or they will go elsewhere, maybe to the Caribbean. And don't forget we must be damn sure smart as new paint to have gotten that much paid to us, anyways?” Some people think, small people, that now their time has come to make it in the big leagues! I say little league yes, world series never! America should always be diligent in resisting letting free markets have small people in charge, domestically or internationally, and compensation should not be regulated by any government ratios, otherwise good folk will believe it's ok to work only for the state instead of for themselves? There are limits to compensation and these could be in the same ratio as it is possible to leverage shareholders’ balance sheets and the systemic risks that threaten our planet that only the biggest people should be entrusted with. There were no regulators capable of shepherding the global system. There are no shareholders able to take down richly rewarded directors because that's what shareholders aspire to too, so don't kid yourselves that greed ain't good business sense. I expect to return from my Davos meetings to Wall Street, via Long Island, Miami, Bay Street, and Grand Cayman once the Easter holidaymakers start over-crowding the slopes at Val d'Isere, Wengen and Gstaad where I am always in touch with all of you via my secretary's Blackberry.

GREAT FIRE - TOO CONVENIENT!

Economic and financial recovery is like the film Restoration (1995) from the book by Rose Tremain has drama just like our present recession. The story begins with young doctor, Robert Merivel (Robert Downey), in service of King Charles II (Sam Neill) after saving the King's spaniel. Merivel enjoys a life of hubris and careless pleasure at court, until the King orders Merivel to wed Celia, the King's mistress, basically to get the assets off balance sheet and fool other mistresses. The film opened as world bond markets went into meltdown. At the pre-screenings, the test audiences (Califormian muesli types) the written comments complained that The Great Fire of London seemed like an all too convenient plot device for resolving the story. Harv' Weinstein, a genius producer, furiously dipping into his jelly babies and diet cokes, foresaw a solution and this is why the final film is the first to open with a credits crunching sex scene (that was shot and edited by my brother Laurence - a brilliant cinematographer by the way).
What makes me think of this on the day of the HBOS shareholders' general meeting and vote on the Lloyds TSB takeover (a vote that looks like a totally foregone conclusion) is that I just hope they too have the insight to say hang on, something's just too convenient here, we're being tricked into selling out far too cheap!? The answer stands or falls on how unavoidably and all-destructive the Great Fire or Credit Crunch recession really is for these banks?
This morning, I also get an insightful email from Melvyn Bragg about the Great Fire: "Here are some observations and excerpts from the two great London diarists of the time, Samuel Pepys and John Evelyn. It seemed that people looked first and foremost to saving their own goods and getting out of the path of the flames, rather than considering what might be the best way to act in order to stop the fire outright. Pepys described in his diary entry [a dossier by a Government official that remained secret for 200 years] on 2nd September how he observed “Everybody endeavouring to remove their goods, and flinging into the river or bringing them into lighters that lay off; poor people staying in their houses as long as till the very fire touched them, and then running into boats, or clambering from one pair of stairs by the water-side to another…Having staid, and in an hour's time seen the fire rage every way, and nobody, to my sight, endeavouring to quench it, but to remove their goods, and leave all to the fire…” Pepys described the voracity of the fire in great detail and wrote how,as he walked along with his wife “all over the Thames, with one's face in the wind, you were almost burned with a shower of firedrops. This is very true; so as houses were burned by these drops and flakes of fire, three or four, nay, five or six houses, one from another. When we could endure no more upon the water; we to a little ale-house on the Bankside, over against the Three Cranes, and there staid till it
was dark almost, and saw the fire grow; and, as it grew darker, appeared more and more, and in corners and upon steeples, and between churches and houses, as far as we could see up the hill of the City, in a most horrid malicious bloody flame, not like the fine flame of an ordinary fire…We staid till, it being darkish, we saw the
fire as only one entire arch of fire from this to the other side of the bridge, and in a bow up the hill for an arch of above a mile long: it made me weep to see it. The churches, houses, and all on fire and flaming at once; and a horrid noise the flames made, and the cracking of houses at their ruins. So home with a sad heart…” (entry for 2nd September)
The diarist and town-planner, John Evelyn, described in his diary of 2nd September how the fire “continued all this night, which was as light as day for ten miles round, in a dreadful manner, I went on foot to the same place. The conflagration was so universal, and the people so astonished, that from the beginning they hardly stirred to quench it, so that there was nothing heard or seen but crying out and
lamentation, running about like distracted creatures, without attempting to save even their goods. It leapt after a prodigious manner from house to house, and street to street, at great distances one from the other. Here we saw the Thames covered with goods floating, all the barges and boats laden with what some had time and courage to save. And the fields for many miles were strewn with movables of all sorts, and tents erecting to shelter both people and what goods they could get away. Oh, the miserable and calamitous spectacle! London was, but is no more!”
For London then read Edinburgh and Scotland today!

WHEN BANKS MERGE?

The merger of Lloyds TSB and HBOS is at risk of becoming a nightmare for both banks at a time when there are nightmares a plenty in the markets and the economy. This is a time for J. Shumpeter's 'creative destruction' (see comment below). It will be two steps back for one step forward. Why?
Lloyds TSB expects to integrate HBOS and achieve 'synergies'. At the same time the whole of both banks have to be shrink-washed, assets run-down and a new economic capital model created as condition of redeeming the Government's 43+% shareholding. Lloyds is already planning what to writedown and sell-off including talking with potential buyers for this or that even before the deal is finally certain. HBOS has moved half a £billion of PFI assets off balance sheet and sold some non-banking holdings as well as Westpac Bank (for a fraction of its book value). In the merger process 20,000 jobs are expected to be cut. HBOS staff can expect to bear the brunt of this and they are all distinctly queasy, angry, and unhappy. What is the risk-value of merging with a distressed bank and uncooperative, or let's say less than enthusiastic, staff? Lloyds will use as its template how Royal Bank of Scotland integrated the operations and systems of NatWest a decade ago. That time the cost (external not internal) was somewhere in the region of £3 billions. Cost savings, called 'synergies', are expected to be worth £1.5bn a year. But it will take several years to get to that. HBOS's internal systems are probably much supperior to Lloyds, but Lloyds has the whip hand in this merger. Lloyds general ledger core accounting is reputedly a 30 year old model long past its replacement date. A 4 year old project to modernise financial reporting within the bank has been cancelled half way through? HBOS had problems in integrating with Halifax. But this was a merger of equals (financially) and much effort was expended to choose and keep the best, and anyway the two bamks had so many complementarities that integrating into a single contiguous system at all levels and across all business units was thankfully not worth doing.
Deloittes, the audit and consulting firm, emailed me recently about bank mergers to say, "...All those dreams of capturing synergies through higher revenues and lower costs may turn to dust if you don’t incorporate information technology (IT) into the integration process from start to finish. By failing to invite IT to the party, companies may overpay for an acquisition and suffer buyer’s remorse down the road. And once the transaction is completed, IT still has a crucial role to play in whether the expected synergies actually deliver on the promise of the deal. Here’s the bottom line: Integration without IT is no integration at all". Synergies, if narrowly cost-ratio determined, are illusory anyway in my extensive experience - they are demanded by stock market analysts as a fig-leaf wanting to be told the values-added of "why buy?", when the real why buy is simply for bigger market share. But, when two big players merge in markets where players trade directly with each other, the merger wipes out a large slice of the markets' in depth liquidity. And this also happens in domestic traditional banking. A lot of assets are borrowings by households and businesses merely to re-cycle other loans with other lenders. So when LTSB and HBOS merge they make UK domestic banking volume smaller. The 'velocity of capital' in the UK economy will fall significantly, and do so when it is alreday falling too much anyway (credit crunch + recession). This is not good for anyone. Mergers in such conditions will find that expected gains prove largely illusory, a mirage in a fast desertifying landscape.
M&A projects all too readily assume integration is worthwhile and forgets that one or more company cultures (internal brand value, procedures & processes - very delicate) is destroyed and a new culture has to be created. This is why it is two steps back for one step forward. It is like taking two different very fine highly elaborate swiss watches, taking them to bits and trying to build a new watch with a mix of bits from both the originals. It doesn't work. So what happens - a whole new bank infrastructure and IT systems need to be bought in, tailored, legacy data populated into new gone live systems, tested and tested again many times, rolled out operationally, training and more training, bug fixing and more bugs - an endless cycle of improvements and replacement that should take normally no more than 18 months but will take a full 5 years, by which time half of everything is outdated and needs replacing again!
Far better is to maintain the banks as separately operating entities under a holding company and only judiciously integrate beginning at the top and moving down layer by layer and business unit by unit only as and when business cases are convincing and change necessary. Cultural changes take time. Banks are not standard machines; they are people businesses with quirky and highly-elaborated unique systems that are very complicated to intergrate. There is no way that everything can be changed at the same time. This would overwhelm management resources as well as intellectual and technical skills available to the bank and available in the marketplace. Some people use the analogy of merging two railways with different gauge size of tracks. It is not like that. My advice: forget root and branch integration synergies and stick to what really matters especially at this time which are economic risk management and financial risk accounting.

MAG v. Secretary of State (Lloyds TSB takeover of HBOS)

In this case before the Competition Appeal Tribunal Merger Action Group (www.mergeractiongroup.org.uk) challenges the Secretary of State's assertion (a Government discretionary decision, 18 & 31 September) that the takeover of HBoS by LTSB not be referred to the Competition Commission (CC) because the public interest of Financial Stability is greater than competition issues. In effect, Government (and the two banks) either know and accept that competition in UK domestic banking will suffer and/or they have good grounds for believing this merger is so urgently vital in the interest of the stability of the UK financial system that there is no time for a referral, and/or the Government has good grounds for believing this merger would not be against the public interest to have competitiveness among UK banks maintained.
The two banks will enjoy roughly 30-40% of UK domestic banking, which is twice the level considered a 'dominant' position. To be in a position of dominance, a business must have the ability to act independently of its customers, competitors and consumers. Establishing if a company is dominant requires a complex assessment of a number of elements but, as a general rule, if a business has a 50% market share there is a presumption that it is dominant. However, dominance has been found to exist where market share is as low as 40% and even 15%. To be a major player in a market only requires 5% market share. Under EU law, Article 82 requires dominance in a substantial part of the European Union, but there is no requirement under Chapter II that a dominant position must be held in a substantial part of the UK, meaning that, in theory at least, dominance could be considered to exist in a fairly small area of the UK e.g. Scotland or North of England or even a sub-region.
Having a dominant position does not in itself breach competition law. It is the abuse of that position (or the potential for likely abuse in the absence of safeguards) that is prohibited. Examples of behaviour that could amount to an abuse by a business of its dominant position include:
- imposing unfair trading terms, such as exclusivity e.g. in factoring by banks;
- excessive, predatory or discriminatory pricing e.g. in mortgages;
- refusal to supply or provide access to essential facilities e.g. SME overdrafts;
- tying e.g. stipulating a customer for one loan product must also purchase all or some of a second product such as insurance.
In this context it is a powerful statement by the OFT that competition will be damaged according to the conclusions of its report, which is why MAG wants the merger referred to the CC. Exceptions may be sought if some other larger benefit of the merger is sufficient to substantially outweigh a loss of market competitiveness. And this benefit should be long term, not just a short term benefit! But, as Sir Ian Burt and Sir George Mathewson reasonably stated (two senior bankers who should know intimately about these things) in their published letter, financial market conditions have changed since 18 September such that financial stability should not be an issue following the Government's intervention (£56bn) to supplement the reserve capital of UK banks of systemic importance. Therefore, they say that the benefit of financial sector stability is no longer served by this merger and no longer relevent as a reason for not referring the merger to the CC. The Government based its decision on the views of the FSA, which MAG asserts are irrelevent and/or has failed to respect section 46(2) of the Competition Act (1998) and is seeking an order quashing the Secretary of State's decision pursuant to the power conferred by section 120(5) of the Act.
Clearly, stability is a short term concern while market competitiveness is a longer term concern. But, the latter appears to be of substantially less importance to Government (deciding on behalf of the general public interest). The Government's reliance on advice from the FSA is odd insofar as it is the Bank of England, not the FSA, that is responsible for UK financial sector stability. The FSA is responsible for UK financial sector resilience. If the Government's decision had been based on 'resilience' not 'stability' its argument might appear more valid. There is absolutely nothing in the Bank of England's many reports, especially in any of its Stability Reports/Reviews that indicate bank mergers as a factor of interest or concern in this context? The FSA states on its website merely, "The announcement of the proposed merger with Lloyds TSB is a welcome move as it is likely to enhance stability within financial markets and improve confidence among customers and investors in the UK financial sector." There is no basis offered for this claim? The FSA adds that "The merger will be subject to shareholder approval and approval by the FSA, OFT and some overseas regulators." But, the OFT does not approve. On 24th October it recommended referring the merger to the CC, advice overriden at the discretion of the Secretary of State on 31st October. The report, which the OFT submitted to the Secretary of State on 24 October 2008, contains the following advice and decisions: there is a realistic prospect that the anticipated merger will result in a substantial lessening of competition in relation to personal current accounts (PCAs), banking services for small and medium sized enterprises (SMEs) and mortgages . The OFT's concerns on PCAs and mortgages are at the national (Great Britain) level, while its concerns on SME banking services are focused on Scotland. In addition, the OFT cannot exclude competition concerns arising at the local level in relation to PCAs and SME banking services. No further competition concerns are considered to arise in relation to the other identified overlaps between the parties in retail banking (savings, wealth management, personal loans, credit cards and pensions), corporate banking (banking services to large corporations, asset finance/fleet car hire) and insurance (PPI, life, general), and in the absence of any offer of remedies from the parties, it would not be appropriate to deal with the competition concerns arising from the merger by way of undertakings in lieu of reference to the Competition Commission. The OFT finds that the combined market share of HBoS & LTSB would be 30-40%! The challenge by the Merger Action Group (MAG) should be allowed to challenge the basis for the Government's belief i.e. whatever technical advice it received whereby it considered it could anticipate or make unnecessary a full enquiry by the CC. Information required from the two banks on this question are determined to be business-confidential and therefore can be delivered in summary only to MAG and the Tribunal?

NOTES
Details of Competition Appeal Tribunal procedures are at www.catribunal.org.uk
Merger Action Group (“the Applicant”), is an unincorporated association of persons and businesses established in Scotland, challenging a decision by the Secretary of State for Business, Enterprise & Regulatory Reform (contained in a document entitled “Decision by Lord Mandelson, the Secretary of State for Business) not to refer to the Competition Commission the merger between Lloyds TSB Group plc and HBOS plc under Section 45 of the Enterprise Act 2002 dated 31 October 2008” (“the Decision”). On 18 September 2008, the former Secretary of State, the Rt. Hon. John Hutton, issued a notice to the Office of Fair Trading (“OFT”) pursuant to section 42 of the Act (“the intervention notice”) stating that the stability
of the financial system in the United Kingdom ought to be specified as a public interest consideration in section 58 of the Act. The Secretary of State further stated that the stability of the UK financial system may be relevant to a consideration by the OFT of the merger situation arising out of the proposed merger
announced by Lloyds TSB Group plc (“Lloyds TSB”) and HBOS plc (“HBOS”) on 18 September 2008 (“the Merger”).
The intervention notice required the OFT to investigate and provide a report to the Secretary of State in accordance with section 44 of the Act within the period ending on 24 October 2008. The intervention notice also indicated that the Secretary of State would lay before Parliament for its approval an affirmative resolution to specify the new public interest consideration under section 58 of the Act. The relevant order completed Parliamentary scrutiny on 23 October 2008 and came into force on 24 October. The new public interest consideration has been added to the Act as section 58(2D). The OFT produced a report under section 44 of the Act dated 24 October 2008 entitled “Anticipated acquisition by Lloyds TSB plc of HBOS plc” (“the Report”)2. The Report includes decisions to the effect that it is or may be the case that arrangements are in progress or in contemplation which, if carried into
effect, will result in the creation of a relevant merger situation and the creation of that merger situation may be expected to result in a substantial lessening of competition (“SLC”) within a market or markets in the United Kingdom for goods or services, including personal current accounts, banking services to small and
medium enterprises and mortgages such that further inquiry by the Competition Commission (“the CC”) is warranted. The Report also provides that any relevant consumer benefits did not outweigh the SLC and it would not be appropriate to deal with the matter by way of undertakings under paragraph 3 of Schedule 7 to the Act. In deciding whether to make a reference to the CC under section 45 of the Act, the Secretary of State is required, under section 46(2) of the Act, to accept the decisions of the OFT as to the creation of a relevant merger situation which may be expected to result in SLC.The Decision states that the new public interest consideration contained in section 58(2D) of the Act, the stability of the UK financial system, is relevant to this case and that taking account only of the SLC and the public interest consideration, the Secretary of State believes that the creation of the relevant merger situation is not expected to operate against the public interest. The Secretary of State considers that the Merger will result in significant benefits to the public interest as it relates to ensuring the stability of the UK financial system and that these benefits outweigh the potential for the Merger to result in the anti-competitive outcomes identified by the OFT. The Decision (www.berr.gov.uk/files/file48745.pdf) states that no reference will be made to the CC (Competition Commission).

REFERENCES
1998 Competition Act - http://www.statutelaw.gov.uk/legResults.aspx?LegType=All+Primary&PageNumber=18&NavFrom=2&activeTextDocId=1455848
Case Name: Merger Action Group v Secretary of State for Business, Enterprise and Regulatory Reform
Case Number: 1107/4/10/08 Date Registered: 28 November 2008
Status: Summary of application published on 1 December 2008. By an Order of the President, made on 1 December 2008, the time for making a request for permission to intervene was abridged until 5.00pm on 2 December 2008. A case management conference took place on 3 December 2008 when HBOS plc and Lloyds TSB Group plc were granted permission to intervene. A hearing has been fixed for 12pm on 8 December 2008 with a time estimate of one day.
Tribunal: President - Sir Gerald Barling, Michael Blair QC, Professor Peter Grinyer
Documents: Order of the Tribunal (Confidentiality ring) - (17Kb) 03 December 2008
Order of the Tribunal - (17Kb) 03 December 2008 (http://www.catribunal.org.uk/documents/Order_proceedings_1107_Merger_031208.pdf)
Order of the President (abridging time for requests for permission to intervene) - (14Kb) 01 December 2008 (http://www.catribunal.org.uk/documents/Order_confidentiality_1107_Merger_031208.pdf)
Summary of application - (42Kb) 01 December 2008
http://www.catribunal.org.uk/documents/Summary_1107_MergerActionGroup_011208.pdf

TURKEYS ON THANKSGIVING

AAA predicts 1.4% fewer Americans will travel 50 miles or more this Thanksgiving. If the prediction proves correct, it will be the first decline in Thanksgiving holiday travel since 2002. The biggest percentage decrease will be in airline travel, a possible 7.2% drop. One exception are only Americans without easy access to a full Turkey spread this Thanksgiving, yet who have travelled furthest - to dine on the Space Station where the inmates there are eating early tonight at the same time as I could see them from my farmhouse at 6:38pm at 12 degrees SSW just above the horizon and clearly visible to the naked eye on a cold stormy night in Scotland! The astronauts normally drink their meals through straws, but like hundreds of millions of Americans, the 7 Endeavour astronauts and 3 permanent crew members are enjoying at least something of a traditional Thanksgiving even if it is only liquidised turkey, cornbread stuffing and green beans. But, unlike earthbound families and colleagues, they're floating while feasting (through straws from plastic sachets, in the shuttle-international space station complex about 220 miles above my head - something of a metaphor for the earth's financial problems. The astronauts, at no expense spared, took delivery of a bathroom, kitchenette, two bedrooms, exercise equipment, but then experienced problems with the system for recycling liquid waste. It purifies sub-prime ingredients, urine, sweat and condensation into just about paletable drinking water. Flight controllers had considered returning the urine-recycling special purpose entity, a $154 million water system, back to Earth. But after 5 days of tinkering, astronauts got it working, and it's now churned out 7 litres of recycled urine & condensation. But NASA wants to test the samples and run the equipment in orbit for at least 3 months (classic 90 days overdue default test) before allowing anyone human to drink the stuff. Meanwhile, what are the turkeynomics back in the real world on Earth USA? Over 46 million USA turkeys get roasted this Thanksgiving! That's 675m pounds weight of turkey (or $1.7bn at $1 for frozen to $4 fresh per pound, up 9 cents or 2%) and full Thanksgiving dinners are costing US celebrants 5.5% more than last year,$44.61, up from $42.26. Many families will not be thanking the turkeys for the credit crunch and recession this year, but most may be thanking their lucky stars they've elected Barack Obama and his team. Like the Obama Government's first budget, however, turkey prices are up 8%. Rolls, cranberries, sweet potatoes and even pumpkin pie are also more expensive. Though if I had turkeys on my farm looking like this they could have the run of the garden and I'd never eat it, valuing its decorative value more.But, as in any recession, the higher prices are not showing up in corporate profit statements, and in the case of many banks the turkeys are not even showing up for work at all this Thanksgiving, a finance sector non-sequitor? What happened is that commodity costs like home prices rose faster than consumers are willing to pay, resulting in lower gross margins all round that threatens the solvency of turkey wholesalers and retailers. President Bush in time-honoured fashion will be using his Presidential Pardon to pardon several turkeys connected to his outgoing amionistration. But, first he gets to pardon a feathered turkey, pardoned. As usual in recent years, the lucky henbird is some luckless variety from some Guantanamo style white battery cage, looking cowed and fearful; wouldn't squawk at a goose or a Bush, very unlike the more traditional image of an organic bird in colourful plumage and bonnet-style headress. Financial turkeys of 2008 must include all the banks that lost most of their share price since August and those that faile doutright especially Lehman Brothers' bankruptcy, Paulson's Troubled Asset Relief Program which didn't exactly do what it said on the label, Merrill-Lynch spending $5.27bn buying its own stock at $84.88 per share (now $11.53), TPG (Texas Pacific Group) putting $7bn into WAMU 5 months before regulators wiped out shareholders, Fannie Mae and Freddie Mac, and AIG, and in Europe, the hapless demise of Fortis, Hyporeal, Dresdner, HBoS's botched share-sale and subsequent collapse followed by RBS and now Bank of Ireland looking like it might sell 2/3 of itself for even less good value than Barclays is getting for 1/3, and others too nauseating to recall, except for two recent bank closures. Regulators shut down Houston-based Franklin Bank and Security Pacific Bank in Los Angeles on Friday, bringing the number of failures of federally insured banks this year to 19. The Federal Deposit Insurance Corp. was appointed receiver of Franklin Bank, which had $5.1 billion in assets and $3.7 billion in deposits as of Sept. 30, and of Security Pacific Bank, with $561.1 million in assets and $450.1 million in deposits as of Oct. 17. The turkey here has to be co-founder and chairman of parent Franklin Bank Corp, Californian, Lewis Ranieri, who invented mortgage-backed securities two decades ago, but was unable to save his own company from getting ensnared in the home-loan bust.Today's economic news from Thanksgiving USA include the following: Not good news that new unemployment claims fell this week to 529,000 from 543,000 last week! US unemployment is now at its highest since 1983. Personal Income rose at an annual rate 0.3% in October, up from 0.1% in September, while personal pending fell 1% month on month, a big drop, largest fall since 9/11. But it tells us household savings are increasing. New Home Sales fell, confirming a 40.1% annual fall, lowest since 1982. Inventories are now 3 times that of good years (4 months worth of new sales). Orders for durable goods of all kinds fell 4-7%. There is however sign of a little recovery in consumer confidence, but it is likely to be temporary as rising unemployment has still some way to go. There are reasons to think that stock markets have become so cheap it may be profitable, very profitable to buy equities again. This is a global business. My personal view is that a 5-6 months bull run is possible, after which the markets should sag and fall again. The most important investor sentiment with global impact is that of the USA and it is showing a mixed picture with only a possible shading in favour of bullishness. My personal view is that this cannot begin to become solid until real estate prices bottom out and begin rising, at least look as if the fall-off is slowing and the market turning. If home prices are to fall to the long run trend they have to fall half as much again from the 20% fall to date. To end on a more festive note the following image was sent to me as a celebratory greeting for Thanksgiving, which I pass onto all my American friends.

Crunch Images of US Bank Sector Losses

More Institutions Report Declining Earnings, Quarterly Losses: Troubled assets continued to mount at insured commercial banks and savings institutions in the third quarter of 2008, placing a growing burden on industry earnings. Expenses for credit losses topped $50 billion for a second consecutive quarter, absorbing one-third of the industry’s net operating revenue (net interest income plus total noninterest income). Third quarter net income totaled $1.7 billion, a decline of $27.0 billion (94.0 percent) from the third quarter of 2007. The industry’s quarterly return on assets (ROA) fell to 0.05 percent, compared to 0.92 percent a year earlier. This is the second-lowest quarterly ROA reported by the industry in the past 18 years. Evidence of a deteriorating operating environment was widespread. A majority of institutions (58.4 percent) reported year-over-year declines in quarterly net income, and an even larger proportion (64.0 percent) had lower quarterly ROAs. The erosion in profitability has thus far been greater for larger institutions. The median ROA at institutions with assets greater than $1 billion has fallen from 1.03 percent to 0.56 percent since the third quarter of 2007, while at community banks (institutions with assets less than $1 billion) the median ROA has declined from 0.97 percent to 0.72 percent. Almost one in every four institutions (24.1 percent) reported a net loss for the quarter, the highest percentage in any quarter since the fourth quarter of 1990, and the highest percentage in a third quarter in the 24 years that all insured institutions have reported quarterly earnings. Lower Asset Values Add to the Downward Pressure on Earnings: Loan-loss provisions totaled $50.5 billion in the quarter, more than three times the $16.8 billion of a year earlier. Total noninterest income was $905 million (1.5 percent) lower than in the third quarter of 2007. Securitization income declined by $1.9 billion (33.0 percent), as reduced demand in secondary markets limited new securitization activity. Gains on sales of assets other than loans declined by $1.0 billion (78.7 percent) year-over-year, and losses on sales of real estate acquired through foreclosure rose by $518 million (588 percent). Among the few categories of noninterest income that showed improvement, loan sales produced net gains of $166 million in the third quarter, compared to $1.2 billion in net losses a year earlier, and trading revenue was up by $2.8 billion (129.2 percent). Sales of securities and other assets yielded net losses of $7.6 billion in the third quarter, compared to gains of $77 million in the third quarter of 2007. Expenses for impairment of goodwill and other intangible asset expenses were $1.8 billion (58.6 percent) higher than a year ago. Loan Losses Continue to Mount: The industry reported year-over-year growth in net charge-offs for the seventh consecutive quarter. Net charge-offs totaled $27.9 billion in the quarter, an increase of $17.0 billion (156.4 percent) from a year earlier. Two-thirds of the increase in charge-offs consisted of loans secured by real estate. Charge-offs of closed-end first and second lien mortgage loans were $4.6 billion (423 percent) higher than in the third quarter of 2007, while charged-off real estate construction and development (C&D) loans were up by $3.9 billion (744 percent). Charge-offs of home equity lines of credit were $2.1 billion (306 percent) higher. Charge-offs of loans to commercial and industrial (C&I) borrowers increased by $2.3 billion (139 percent), credit card loan charge-offs rose by $1.5 billion (37.4 percent), and charge-offs of other loans to individuals were $1.7 billion (76.4 percent) higher. The quarterly net charge-off rate in the third quarter was 1.42 percent, up from 1.32 percent in the second quarter and 0.57 percent in the third quarter of 2007. This is the highest quarterly net charge-off rate for the industry since 1991. The failure of Washington Mutual on September 25 meant that a significant amount of charge-off activity was not reflected in the reported industry totals for the quarter.Growth in Reported Noncurrent Loans Remains High: The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) increased to $184.3 billion at the end of September. This is $21.4 billion (13.1 percent) more than insured institutions reported as of June 30 and is up by $101.2 billion (122 percent) over the past 12 months. The percentage of total loans and leases that were noncurrent rose from 2.04 percent to 2.31 percent during the quarter and is now at the highest level since the third quarter of 1993. The growth in noncurrent loans during the quarter was led by closed-end first and second lien mortgage loans, where noncurrents rose by $9.6 billion (14.3 percent). Noncurrent real estate C&D loans increased by $6.9 billion (18.1 percent), while noncurrent loans secured by nonfarm nonresidential properties rose by $2.2 billion (18.1 percent). Noncurrent C&I loans were up by $1.8 billion (13.7 percent) during the quarter. Nine Failures in Third Quarter Include Washington Mutual Bank: The number of insured commercial banks and savings institutions fell to 8,384 in the third quarter, down from 8,451 at midyear. During the quarter, 73 institutions were absorbed in mergers, and 9 institutions failed. This is the largest number of failures in a quarter since the third quarter of 1993, when 16 insured institutions failed. Among the failures was Washington Mutual Bank, an insured savings institution with $307 billion in assets and the largest insured institution to fail in the FDIC’s 75-year history. There were 21 new institutions chartered in the third quarter, the smallest number of new charters in a quarter since 17 new charters were added in the first quarter of 2002. Four insured savings institutions, with combined assets of $1.0 billion, converted from mutual ownership to stock ownership in the third quarter. The number of insured institutions on the FDIC’s “Problem List” increased from 117 to 171, and the assets of “problem” institutions rose from $78.3 billion to $115.6 billion during the quarter. This is the first time since the middle of 1994 that assets of “problem” institutions have exceeded $100 billion. Failure-Related Restructuring Contributes to a Decline in Reported Capital: Total equity capital fell by $44.2 billion (3.3 percent) during the third quarter. A $14.6-billion decline in other comprehensive income, driven primarily by unrealized losses on securities held for sale, was a significant factor in the reduction in equity, but most of the decline stemmed from the accounting effect of the failure of Washington Mutual Bank (WaMu). The WaMu failure had a similar effect on the reported industry totals for tier 1 capital and total risk-based capital, which declined by $33.6 billion and $35.3 billion, respectively. Unlike equity capital, these regulatory capital amounts are not affected by changes in unrealized gains or losses on available-for-sale securities. Almost half of all institutions (48.5 percent) reported declines in their leverage capital ratios during the quarter, and slightly more than half (51.2 percent) reported declines in their total risk-based capital ratios. Many institutions reduced their dividends to preserve capital; of the 3,761 institutions that paid dividends in the third quarter of 2007, more than half (57.4 percent) paid lower dividends in the third quarter of 2008, including 20.7 percent that paid no dividends. Third quarter dividends totaled $11.0 billion, a $16.9-billion (60.7-percent) decline from a year ago.

ART ATTACK!

The world art market is now crunched too - another financial safe haven bites dust, or as I explained in a conference call earlier to my Paris dealers, "La question de la contagion de la crise financière au marché de l’art est désormais centrale." The signs began in September, though eminently predictable. Some observers claimed the art market had not contracted since 1990, which is nonsense. It declined in the mid-'90s after the 92-93 crash, which hit all luxuries, and again after 2001-03 when a lot of wealthy IT options earners suddenly got hit for capital gains as their share options crashed 90%. Although art values survived 9/11 (when several great collections and collectors were lost in the twin towers and a warehouse fire in East London destroyed a vast collection of Brit Art), the current meltdown of the global financial system has been too much for the "social climbers' investment" market. From January levels, the average prices of auction house art by October was 14.5% down, and that's without a short-selling market. In art all investors go long on illiquid assets and hope that windows of opportunity will suddenly open to sell at a euphoric profit. With hindsight, the market's peak was a year ago. Damian Hirst and Jeff Koons did well, however, before prices deflated. All market segments, all artists - from classic investment grade to top-end speculative to entry-level affordable (<$10,000) - are dragged down by depreciation of "speculative" works, what we financial analysts call high risk high return "Junk". Prices are down in small provincial auction rooms as at major prestigious houses. The value wiped out is undoubtedly in the region of $tens of billions. Demand as ever was driven by the nouveau riche, recently from among the arrivistes of Asia, Russia and the Middle-East that kept prices buoyant until June and allowed savvy Western collectors to offload. Mrs Richard Fuld was a little late into the market but others like Charles Saatchi and Richard Grant among collectors did well. The bought-in rate (buyers failing to come up with the final bid price) has more than doubled in one year, growing from 25% by value at the end of 2007 to 54% in October 2008. Paradoxically, the prices of works presented above the $100,000 line successfully sold remained stable. This is a time to market problem, the period of weeks or months between when works are valued to being published in catalogues to being competed for and orchestrated at the auction sale, so that price adjustments are slow to reflect the actual market. As reserve price estimates are behind market reality, the first supply/demand disequilibria causes a jump in the bought-in rate. I sold parts of my collection recently and had them converted into my own version of Carl Andre's bricks or Damian's skull. Whereas the top-end of the market (4.1% of deals) has shown relative and temporary price inertia, on the more volatile cheaper market segments (less than $100,000) falls have been frictionless and act as lead indicators, falling 18% year to date! We can expect at least the same again in 2009. But, long before prices fall further market illiquidity cuts off further sales other than fire-sales and insurance claims. The impact of the crisis has shaken boardrooms and drawing rooms around the world. The global market is efficient as prices contracted in New York, Paris, Berlin, Rome and London just as it did simultaneously in new growth zones of Hong Kong, Singapore, Shanghai, Tokyo, Sao Paolo, Bombay and Dubai. The very latest results recorded in these new markets are extremely disquieting to those who bought heavily into Chinese art this year on the back of the Olympics euphoria or the new nascent Gulf buying e.g. the $16.9m by Christie’s Mid-East in its October sales in Dubai compared with the $32-43m expected. In Hong-Kong in October '07, Sotheby’s posted a bought-in rate below 10%. A year later, at the same sales, the ratio was 29%. For long term proven fundamentals, if buying contemporary art on Walter Buffet principles, though I doubt he ever bought any investment grade art, I recommend the works of Joseph Beuys (1923-1986), something he'd explain on the blackboard and then have a good laugh at. He still appears in more art shows a year (360+) than Andy Warhol (350+), despite dying 2 years earlier, and the capitalisation value of his entire oeuvre has retained its museum price value of somewhere in the $6billions region. At the beginning of this year, many warned including myself that the art market would see contraction in 2008, notably as ArtPrice put it uniquely "via a recrudescence of buyer vigilance (that) could well start to manifest at auctions". 2009 looks set to be a year of steeper price contraction throughout the entire market. Buying at distress prices is a must for serious collectors. Any investors reading this may wish to join my Art Vulture Fund offering 10 year returns of 200-500%. During the contraction of 1990-92, prices fell 44% in 2 years. This time round I'm expecting 60-80% falls depending on the segment given that in the USA prices rose 67% in 2005-08 and globally (partly currency exchange rate movements) by 48.9% measured in Euros. Part of this year's fall is the strengtening dollar given that most of the worlds' serious collectors live in the USA. Hence high investment grade art can act as a currency risk hedge. Art outpaced equities, though underperformed property. But like any equity market individual gains can greatly exceed the market average or greatly undershoot it. Equity and fixed income markets tend to react immediately to announcements by the Fed, BoE or the ECB in seconds. The art market functions with a different rhythm but is at least as vulnerable to insider trading and system gaming. But more like the real estate market, the art market has a natural "interval" between cause and effect with transactions often taking several months to conclude.
This time round, however, the art market barometer dropped 13% at the start of October in unison with the sharp falls on stock markets. Such prices falls will not effect tight markets for great dead artists where the work is in short supply and hard to transport and the artists are widely popular such as Jean Tinguely who turn junk into fine art as opposed to those of a more semantic games-playing approach to art who churn out junk merely for investment. Below is Jean Tinguely's Homage to New York. This may be related to a change in the future evolution of art prices following several exchanges opening to trade art options and futures. Personally, I'm keen to develop an artist limited edition signed bearer bond certificates market price gurantee system whereby artworks can be effectively securitized and have their spreads insured. Whereas over the summer when I found less than a quarter of artists and agnts, gallerists and collectors would openly anticipate a contraction in the fourth quarter, in October at London's Frieze the proportion of bearish embracers of this idea rose to well over half.