December 14 2011: A Glimpse Into the Self-Destructive Psychology of Sharks

Unknown Bass August 17, 1900
A world's record 384-pound black sea bass caught by Franklin Schenck of Brooklyn with rod and reel off Catalina Island, California

Ashvin Pandurangi:

"You cannot survive without that intangible quality we call heart. The mark of a top player is not how much he wins when he is winning but how he handles his losses.

If you win for thirty days in a row, that makes no difference if on the thirty-first you have a bad night, go crazy, and throw it all away."
-Bobby Baldwin

There still remains a large population of stubborn "fish" in the developed world, who are clinging on to hopes of an economic recovery like incredulous poker players cling on to hopes of winning all their money back by playing three cards to a straight or a flush. 

These are the people who continuously get their clocks cleaned and then reload their chips in a vicious cycle of defeat; the people who keep the game alive and profitable for the "sharks".

At the same time, the bankrolls of fish have been diminished so severely and their egos bruised so badly that an increasing number are simply being forced out of the game for good. They can no longer ignore the fact that their lofty expectations have been flattened into silver dollar pancakes, and that they may find themselves lacking food to eat the next day if they continue gambling with what little wealth they have left.

On February 9, I wrote the following:

A Glimpse Into the Stubborn Psychology of Fish

"It's only when the school of fish stream towards the exits in unison that the "game" becomes wholly unprofitable for solid players. Until that tipping point arrives, our bets will continue to scream "I have a monster!" at the top of their lungs, and the fish will continue to make crying calls in stubborn disbelief.

The psychology of fish always leads them from a state of comfortable wealth to one of utter destitution over time, as they incessantly chase their losses, throwing bad money after even worse money.

As the total amount of money sunk into the pot exponentially increases along with net losses, the fish find it that much more difficult to simply walk away from the game. In the long-run, however, every fish goes for broke and is simply unable to purchase any more chips to play with.

The solid players are then left with a minimal or non-existent edge at their tables, as the game begins to consume itself, and that's when you know it's time to get up, leave the casino and begin the long journey back home."

In the financial investment world, anyone still speculating on rising share prices through "buy and hold" strategies, for example, would be labeled a huge "fish". A fish could also be a country such as Croatia, who recently decided to become a member of the EU in 2013. That was a classic move of "chasing" losses, or throwing good money after bad.

After being downgraded to nearly junk status by Standards & Poor a year earlier, and struggling to achieve any economic growth whatsoever, Croatia panicked and stubbornly decided that its best play would be to shove the remainder of its chips into the middle of an imploding European Union, scurrying for the last deck chair on the Titanic.

The most striking example of fish remains the rabid consumers of the developed world, who still feel the need to trample each other during the Holiday season for some sense of short-term gratification. They draw down their savings and run up their credit cards at a time when their jobs could evaporate at any moment along with the value of their assets and retirement accounts.

So while there are still quite a few individuals, corporations and countries harboring the stubborn psychology of fish, it’s also clear that fewer and fewer people and entities can afford to remain in this category – i.e. we have most likely reached the "tipping point". The point where there are no longer enough naive fish for the cut-throat "sharks" to feed on.

A shark is a solid, patient player who immediately assesses the playing styles of his opponents when sitting down at the game, and uses that information to pounce on every single situation in which the shark has a mathematical advantage. The shark is out to maximize value and profits like everyone else, but typically realizes many of his/her own limitations and does not hesitate to sit on the sidelines, patiently waiting for opportunities to strike.

The sharks also have a variety of tools at their disposal, including multi-layered deception and misinformation (something Bill Gross, the notorious financial shark, is familiar with) and an ability to make accurate probability assessments rather quickly with any given hand. Despite all of these advantages, even the most cunning sharks still share one fatal flaw – they are addicted to the game and refuse to quit even as the game collapses in on itself.

The #1 reason the sharks lose money in the medium to long-term is not because of bad luck or better opponents, but rather they beat themselves. They lose patience with bad players, they let their ego get the best of them against good players and they start to take unnecessary risks with their bankroll.

It could start off with small mistakes, such as getting into large pots with other players for the sole purpose of "out playing" them with weak hands, i.e. bluffing them off of the pot. These mistakes simply snowball on top of each other, as the inevitable losses pile up and the players begin to doubt their ability to remain patient and win.
 
Eventually, the losses and frustration build up to such a level that the good player feels compelled to move up in stakes and win some money back. So the player goes from, let’s say, a $500 max buy-in game to a game where one cannot play comfortably without a stack of at least $2000-$3000 in front. At this point, the formerly disciplined players have entered a self-destructive spiral of throwing bad money after good which they are very unlikely to escape from.

In a game of poker, the sharks can either put all of their available capital at risk on one game, or maybe leverage that capital up a few times by borrowing from a - pardon the pun - loan shark or the local bank, but that’s really about it. The desperate sharks in the world of international finance, though, can take their self-destructive attitude to a whole different level of extreme.

The highest stakes game in this world is obviously found within the shadow credit markets, where hundreds of trillions of dollars worth of derivative debt instruments are bought and sold between large institutional players. These games are established by the very largest players in smoke-filled rooms at the back of the speculative casino, and cannot be observed or regulated by any official exchanges.

ZeroHedge has been gradually piecing together what little we know about these "dark pools" to arrive at a more complete picture of how big this shark-infested game really is. It turns out that the total notional value of outstanding "over the counter" derivatives rose to a record $707 trillion in the first half of 2011, which was a $107 trillion increase in six short months. [1], [2]

$707,568,901,000,000: How (And Why) Banks Increased Total Outstanding Derivatives By A Record $107 Trillion In 6 Months

"So why did the notional increase by such an incomprehensible amount? Simple: based on some widely accepted (and very much wrong) definitions of gross market value (not to be confused with gross notional), the value of outstanding derivatives actually declined in the first half of the year from $21.3 trillion to $19.5 trillion (a number still 33% greater than US GDP).

Which means that in order to satisfy what likely threatened to become a self-feeding margin call as the (previously) $600 trillion derivatives market collapsed on itself, banks had to sell more, more, more derivatives in order to collect recurring and/or upfront premia and to pad their books with GAAP-endorsed delusions of future derivative based cash flows.

Because derivatives in addition to a core source of trading desk P&L courtesy of wide bid/ask spreads (there is a reason banks want to keep them OTC and thus off standardization and margin-destroying exchanges) are also terrific annuities for the status quo. Just ask Buffett why he sold a multi-billion index put on the US stock market. The answer is simple - if he ever has to make good on it, it is too late.

The description above almost perfectly captures the self-destructive psychology of sharks in action, as the game enters an entirely new phase of ridiculously high stakes and almost no margin for error. As the value of the shadow debt-derivative system implodes, the financial sharks are forced to throw ever-more leveraged money onto the table until they have nothing left, because the alternative is to simply quit the game and accept their current losses.

Peter Tchir provides some clues into what kind of derivative bets are being placed when he describes "The Ultimate Trade". It was recently revealed that many European banks have been selling large amounts of CDS insurance on the bonds of their home countries, while also buying large amounts of the sovereign bonds themselves. In essence, they are going "all in" on the bet that those countries will remain solvent.

The Ultimate "All-In" Trade

"But why would BSC be so willing to sell protection [on itself]? Well, the markets were very wide because of the fear that they would default. You sell as much protection as possible.

If you default what do you possibly care? Your stock is wiped out, your job is gone, and your strategy is totally explainable to future employees. If you don't default all this massive amounts of protection screams tighter and you have your best year ever. No brainer for the firm, an issue for the market.

So, why are French banks selling protection on France like it is going out of style? Why are Italian banks doubling down on Italy? Because if the bailouts work, it is free money. Huge tightening on top of the spread income until the bailout finally wins. If the sovereign defaults, is the bank really going to be around anyways?

It is the ultimate trade. If you make money, you get paid. If you lose money you were screwed anyways."

For the sharks swimming in the high seas of finance, current losses are so devastating to their balance sheets and their expectations that they cannot even conceive of a worse situation than leaving the game, so they double, triple and quadruple down using whatever capital and whatever leverage they can get their hands on through synthetic financial products. That’s the hallmark of a shark’s psychology right before he/she blows sky high:

"I’m such a clever player, yet so deep in the hole, that there’s no other choice but to let it all ride. Just give me one more game; one more hand to prove myself.

If I win, I’m back even or maybe even booking a healthy profit. If I lose, then I simply end up in the dark and frightening place where I would have ended up anyway."

The reality, though, is that this dark place ends up being much more frightening that anyone could have ever expected. After it’s all said and done, we can be sure the bruised and battered sharks will be begging the Lord Almighty to return them to the place where they were before they decided to make their final stand. But life simply doesn’t work that way, and that’s why we find our economies and societies held hostage to a self-destructive global banking system.

Reuters and Zero Hedge have recently cast some more light on the shadowy games played by the sharks of finance, as they examine the role of the "re-hypothecation" of collateral assets through a never-ending chain of large broker-dealers and banks. Boiled down to its most basic form (which is really all that matters), this process allows a single asset to be pledged as collateral for short-term loans an infinite number of times.

In the shadow banking system, many of these loans take the form of "repo" transactions, where the collateral security is "sold" for cash with the condition that it will be bought back at a specified date and rate of interest. These Escher stairs of OTC transactions, in turn, allow the financial sharks to potentially create an infinite amount of leverage behind their speculative derivative bets.

In this particular game, all of the big-name sharks gather in the City of London, where virtually no restrictions exist on how many times the same collateral can be "re-hypothecated". The following are excerpts and graphs from an IMF report prepared by Manmohan Singh and James Aitken, courtesy of Zero Hedge.

The (sizable) Role of Rehypothecation in the Shadow Banking System

" The United Kingdom provides a platform for higher leveraging stemming from the use (and re-use) of customer collateral. Furthermore, there are no policy initiatives to remove or reduce the asymmetry between United Kingdom and the United States on the use of customer collateral. We show that such U.K. funding to large U.S. banks is sizable and augments the measure of the shadow banking system.

… Rehypothecation occurs when the collateral posted by a prime brokerage client (e.g., hedge fund) to its prime broker is used as collateral also by the prime broker for its own purposes. Every Customer Account Agreement or Prime Brokerage Agreement with a prime brokerage client will include blanket consent to this practice unless stated otherwise.

… On-balance sheet data do not "churn," where churning means the re-use of an asset. If an item is listed as an asset or liability at one bank, then it cannot be listed as an asset or liability of another bank by definition; this is not true for pledged collateral...

However, off-balance sheet item(s) like ‘pledged-collateral that is permitted to be re-used’, are shown in footnotes simultaneously by several entities, i.e., the pledged collateral is not owned by these firms, but due to rehypothecation rights, these firms are legally allowed to use the collateral in their own name."

"Following the collapse of Lehman, hedge funds have become more cognizant of the way the client money and asset regime operates in the United Kingdom. For some, the United Kingdom provides a platform for higher leveraging (and deleveraging) that is not available in the United States.

In general, post Lehman, one would expect an increasing tendency for those providing collateral to counterparties to ask for their collateral to be segregated from the counterparty’s assets and to place limits on its further use.

Our understanding is that the U.K. FSA has not yet made any changes on the use (and re-use)of collateral since their LBIE experience that would remove or reduce the asymmetry in the U.K. and the U.S."

So, there you have it. The financial sharks are sitting down with each other in London to play one last game of incredibly high-stakes poker with infinitely leveraged capital, where absolutely none of them can afford to lose! Some of them will lose, though, and, when one or several major institutions do go down, it will become apparent that none of them really have the actual capital to back up their electronic chips.

In a sense, that is what has already happened with MF Global, and the liquidity crunch was only temporarily stalled by the coordinated action of the Fed and other central banks. To see why, we can return to the original article by Christopher Elias on rehypothecation for Thomson Reuters.

MF Global and the great Wall St re-hypothecation scandal

"MF Global's bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation.

A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet.

The volume and level of re-hypothecation suggests a frightening alternative hypothesis for the current liquidity crisis being experienced by banks and for why regulators around the world decided to step in to prop up the markets recently. To date, reports have been focused on how Eurozone default concerns were provoking fear in the markets and causing liquidity to dry up.

Most have been focused on how a Eurozone default would result in huge losses in Eurozone bonds being felt across the world’s banks. However, re-hypothecation suggests an even greater fear. Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold then a Eurozone sovereign default could be apocalyptic."

As the institutional clients of brokers become increasingly fearful of having their funds effectively stolen through rehypothecation after the MF Global debacle, they will do everything in their power to make sure their cash cannot be further subjected to this process, which will only exacerbate asset sales to meet margin requirements, leading to lower valuations of toxic assets and more funding shortages at banks.
 
The most toxic assets right now are the sovereign bonds of peripheral Eurozone countries, up to and including Italy. If the banks turn to their governments (taxpayers) to re-capitalize them,  then the countries’ own funding needs will worsen as their debt yields go up, which also exacerbates the funding needs of the banks. Yalman Onaran describes this "death spiral" in his article on Bloomberg:

European Banks Taking Cash From Governments Seen Sparking 'Vicious Cycle'

"The size of potential losses at European banks has scared away short-term creditors, squeezing the region’s lenders. The European Central Bank has stepped in to replace funds being withdrawn, providing unlimited cash and lowering requirements on the quality of collateral it will accept.

"We’re in a death spiral," said Andy Brough, a fund manager at Schroders Plc in London. "As the yields on the peripheral bonds increase, value of the bonds decreases and the amount of capital the bank has to raise increases."

Basically, the amount of actual capital available for the pot continues to rapidly shrink, while the sizes of the outstanding bets and raises remain the same – a theme well-known to readers of The Automatic Earth. The central banks are trying to hold back a tsunami of margin calls that will produce waves of potentially infinite height, and therefore there is no way they can hold them back for very much longer.
 
As llargi at The Automatic Earth outlined in his post, Cash for Christmas, the funding situation for European banks remains dire despite the coordinated CB swap lines designed to lower the short-term cost of borrowing dollars, perhaps because there is a massive shortage of euro funding as well, and there is very little chance it will improve.

What is truly frightening about these financial sharks is that their predictable psychology ends up being much more destructive to the rest of society than to themselves. In a poker game, the sharks playing recklessly outside of their bankrolls will self-destruct, go home in tatters and perhaps drink themselves into a coma.

In the game of high finance, though, the sharks will be bailed out and/or go home with much their personal wealth intact, after the institution’s shareholders, creditors, employees, customers and just about everyone else associated with it is wiped out.

The sad fact is that we are all currently a part of their reckless poker game, whether we like it or not.  There is only one way around that - the people must force their governments to hold the bankers criminally, civilly and financially liable for their actions and losses.

If that doesn’t happen very soon, through whatever means necessary, then the only other option is to insulate yourself from the fallout through whatever means you are able and willing to undertake. The long journey from the casino back home is well underway, and now we must simply make it to that home, safe and sound.

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American privilege rots an empire from within
by Andy Xie - Caixin

A rising empire rewards people who contribute to its growth and invest in its future. The empire’s decline begins when certain members of society are over-rewarded by means of privileges, and the empire’s money is wasted on outdated endeavors.

Today, America rewards the wrong people and spends disproportionately on projects of the past. Symptoms of the flawed incentive system in the U.S. economy include a massive fiscal budget deficit, high unemployment rate, crumbling infrastructure and a failing basic education system.

International competition isn’t threatening the United States, but internal problems are. And unless the United States tackles its wrong-way incentive system and spending spree soon, its gradual decline will continue until it eventually joins the likes of Latin America.

A serious effort to correct the U.S. course started in earnest a few months ago during a congressional fight over raising the national debt ceiling. Democrats and Republicans eventually agreed to mandate $1.2 trillion in budget cuts over 10 years through a “super” committee, which was assigned to work out details.

If the super committee failed to reach an agreement, the cuts would be proportionally slapped on future civilian and defense expenditures, with health care and social security programs exempted. Guess what happened? The committee failed to reach a compromise, and thus the consequences will be felt after mandated cuts begin in 2013.

Next year’s election may change the political landscape: One party may again dominate Congress and the White House, leading to a different outcome. Hence, the super committee’s failure isn’t consequential on its own, but it does provide ammunition for election campaigns, and offers another example of America’s dysfunctional political system.

Further, the cuts, even if successful, would not bring the U.S. government budget under control. The total amount on the chopping block is equal to less than one year’s deficit. That’s not very ambitious for a 10-year program.

Against this backdrop, the United States is experiencing a full-blown economic crisis. The nation’s real unemployment rate, which includes idled workers who’ve given up looking for jobs, is 18%. One-tenth of the nation’s properties have been foreclosed since 2007, and another tenth have negative equity.

The poverty rate is more than 15%, and another 20% of the population is struggling on incomes near the poverty line. Looming over these grim statistics is the federal government’s budget deficit, which is equal to about 10% of the nation’s GDP.

The breakdown began with the 2008 global financial crisis, which was like a dam break. Problems had been accumulating for years, and a debt bubble had merely temporarily covered up problems. Now, the U.S. government borrows roughly 40 cents for each dollar spent.

Alan Greenspan, a former U.S. Federal Reserve chairman, was mainly responsible for creating the bubble. The fiscal balance was later wrecked by rising health care costs, social security payments and defense spending along with veteran’s benefits.

Spending on these three items alone increased a combined 107% between 2000 and 2010, while nominal GDP rose only 45%, to $2.6 trillion — substantially more than total fiscal revenues. If spending on these three items had grown at the same pace as nominal GDP, the fiscal deficit would be less than half of what it is today.

How bad is it? Excessive health care spending tells part of the story, eclipsing the U.S. trade deficit in seriousness. Some 17% of the nation’s GDP is spent on health care — twice as much as in other developed economies — with about half paid by federal and local governments, and the other half covered by businesses and individuals. Unless these costs are brought under control, America will never resolve its fiscal crunch.

Ironically, excessive health care spending hasn’t produced a healthier population. The United States actually fares worse than other developed countries in areas such as life expectancy, diabetes and cardiovascular disease.

Unlike Europe and Japan, the United States has a growing population. So it could count on growth to solve problems. Its agriculture and mining industries are booming. And it has many competitive companies in industries in areas such as aerospace and pharmaceuticals. But it’s weighed down by excessive overhead costs such as health care, social security and defense.

The Occupy Wall Street movement drew attention to what organizers said was a huge gap between the 99% of the nation’s citizens whose lives are out of synch with the 1% wealthiest Americans.

The top 1% control about one-fifth of the nation’s income and two-fifths of the wealth. The top 10% take in about half of all income and have accumulated 80% of the wealth. Meanwhile, about 80% of Americans merely get by and have very little wealth available as a cushion for when personal finances turn down.

The gap between the rich and the rest, which has roughly doubled over the past two decades in the United States, is an inevitable result of competition. Of course, competition motivates people, and inequality is often a price worth paying if it motivates people to make the pie bigger.

All could be better off with a bigger pie, even if inequality worsened. Limiting competition improves equality but decreases incentives for people to work. A society needs to make a trade-off between the two.

Inequality worsens in an environment of limited competition, as inefficiency and social friction rise. Examples of this phenomenon include the Philippines, where few families rule through monopolistic practices. The country has become poorer relative to others over the past two decades, while inefficiencies are supported by Filipinos who work abroad and send money home.

Many Latin American countries fall into this category, too, and the United States is heading that way.

Fat paychecks
Most of America’s well-to-do are corporate executives, doctors, lawyers, bankers and the like. Their rewards are tied to positions, not performance. Corporate managers are paid a lot more than average employees, even if they’re not worth it.

For example, one report said salaries for big U.S. company CEOs have jumped to 343 times the average pay for their own employees, up from 42 times in 1980. Of course, a CEO whose work generates a lot of value deserves a decent slice.

But look at the stock market: Common shareholders have done terribly over the past decade. How can CEOs justify millions in take-home while shareholders — their bosses in theory — do so poorly. I’m sure the compensation consultants can come up with good excuses. But this has been going on for years.

Of course, when CEOs make tens of millions of dollars, their immediate subordinates can make millions. These steep compensation levels for executives are a major reason for rising inequality in the United States. And judging from stock performances, many executives don’t deserve fat paychecks.

When big companies started rising in the early 20th century and managers, not shareholders, took control, theorists tried to explain why it was efficient. But as managers essentially decide
their own compensation, large companies eventually exist for the benefit of managers, not shareholders nor workers. A board of directors is supposed to look after shareholders’ interests, but in reality, most boards are stuffed with friends of the CEO.

One could argue that the economic failure of the United States is not the fault of but the sabotage of capitalism. Indeed, corporate governance is breaking down, and that’s one of the most important causes of America’s current economic troubles.

Likewise, reaping unmerited compensation are highly paid financial professionals. Salaries in the financial industry have risen despite the sector’s collapsing firms, shareholder wipe-outs and taxpayer bailouts. This industry certainly has worked neither for the economy nor shareholders.

Lawyers are another group of well-paid professionals who maintain the rule of law. But the United States suffers from an oversupply of lawyers, which forces some to look for ways to circumvent or take advantage of the system.

The most extreme example is the professional niche of ambulance chasers who are busy seeking ways to sue hospitals, doctors and insurance companies. High-end lawyers working for corporations are busy helping corporate managers maximize benefits without breaking rules. How’s that for no added value?

Now, we come to health care. Doctors and hospitals in the United States charge more for their services than in other countries, yet the U.S. population’s health condition proves more spending doesn’t yield better results. Neither does competition work in the health care market, as the information asymmetry between patients and doctors seriously decreases the effectiveness of market competition in allocating resources.

Because patients are vulnerable and must accept what the doctors say, the health care market has a naturally inflationary tendency. Doctors are biased toward expensive treatment. Prices rise easily in a system in which patients are insured and, hence, not resistant to high prices. Of course, insurance premiums rise to reflect costs, too.

In other developed countries, the runaway tendency of health care costs is checked by government limits on doctor charges to ration services. While many argue the United States delivers better services in some areas, isolated examples can’t justify a system that costs twice as much and delivers a less healthy population.

Growing old
To understand the American government’s fiscal trouble, one must study the American Association of Retired Persons, which has more than 40 million members. They constitute a huge bloc of voters in national elections, and their biggest financial concerns are health care and social security.

Some 45% of federal expenditures go toward health and social security programs. This slice of the spending pie is expected to rise to 51% of total expenditures by 2016. Unless something happens that suddenly disrupts this upward spiral, these two parts of the fiscal budget will bankrupt the country.

Meanwhile, the federal government spends a mere 3% on education. Local governments fund most education services through property taxes, yet it’s shocking to see how little the federal government supports youths as opposed to retired people.

In addition to rewarding the right people, an empire rises by investing in the future. The United States went on a massive investment boom in late 19th and early 20th centuries, creating a superpower. An infrastructure program in the 1950s and information technology investment in the 1970s strengthened its superpower status after World War II.

But America has moved in the opposite direction over the past two decades. Its crumbling infrastructure is a sign that money has been diverted to support retirees. The number of wealthy Americans willing to support charity in the pattern set by the likes of Bill Gates and Warren Buffett are dwindling.

The financial crisis in 2008 and the current fiscal crisis are merely symptoms of deep structural problems in American society. Only a popular awakening and strong leadership can solve these problems and prevent the United States from following calling the International Monetary Fund and asking for a bailout.

Historians have all sorts of theories on why the Roman Empire fell, blaming everything from religion to barbarians. My take is that every empire in history eventually rots from within when privilege, not contribution, becomes the basis for compensation.

The children of the ones who contributed take advantage of their status as the offspring of the empire-builders. They can live comfortably, enjoying easy rewards, even as their neighbors lose jobs and homes. We’re seeing the consequences of this phenomenon today in America.

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Britain is ruled by the banks, for the banks
by Aditya Chakrabortty - Guardian

Is David Cameron's kid-glove treatment of the City remotely justified, when it neither pays its way nor lends effectively?

The national interest. It's a phrase we've heard a lot recently. David Cameron promised to defend it before flying off last week to Brussels. Eurosceptic backbenchers urged him to fight for it. And when the summit turned into a trial separation, and the prime minister walked out at 4am, the rightwing newspapers took up the refrain: he was fighting for Britain.

In the eye-burningly early hours of Friday morning, exhausted and at a loss to explain a row he plainly hadn't expected, Cameron tried again: "I had to pursue very doggedly what was in the British national interest."

As political justifications go, the national interest is an oddly ceremonial one. Like the dusty liqueur uncapped for a family gathering, MPs bring it out only for the big occasions. And when they do, what they mean is: forget all the usual fluff about ethics and ideas; this is important.

You heard the phrase last May, as the Lib Dems explained why they were forming a coalition with the Tories. More seriously, Blair used it as Britain invaded Iraq.

But here Cameron wasn't talking about foreign policy; nor about who governs the country. The national interest he saw as threatened by Europe is concentrated in a few expensive parts of London, in an industry that would surely come bottom in any occupational popularity contest (yes, lower even than journalists): investment banking.

In its haste to depict events as Little Britain v Big Europe, the Tory press hasn't dwelt on the inconvenient details of last week's fight. But it was only after the prime minister failed to secure protection for the City from new financial regulation mooted by the EU that he told Nicolas Sarkozy to get on his vélo.

On one issue in particular, Cameron had a good case: Britain wants banks to put more money aside for a rainy day than the EU is considering. Elsewhere, he just looked unreasonable – what exactly is wrong with having international banking supervision? One reason for the euro crisis was that its members have 17 national bank watchdogs and barely anyone looking across borders.

Step back from what even EU officials were calling "arcane" details, though, and the big principle is this: the prime minister effectively stuck relations with the rest of Europe in the deep freeze in order to protect one sector of the economy.

In my recollection, no British minister in recent times has termed one industry as being of "national interest". "Vital" or "key"? Why, such words are the very currency of the MP's address to a trade association. But on the big phrase, I asked the Guardian's librarians to check the archives from 1997 onwards. They came back empty-handed.

Cameron is merely expressing more openly something Labour frontbenchers also believe: that the City is pretty much the last engine functioning in Britain's misfiring economy. Indeed, one of the Labour lines of attack against Cameron this weekend has been that he has left the City more open to regulation.

A few weeks ago, the shadow chancellor Ed Balls warned against any further taxes on financial trading within Europe. However, he said, he would urge a "Robin Hood tax with the widest international agreement". In other words, Balls will give his fullest support to something that has no chance of happening.

This is the same kind of political subservience towards the City, observed by the Financial Services Authority (FSA) in its report into the collapse of RBS. According to the watchdog, a major reason why Fred Goodwin wasn't checked as he drove RBS off a cliff was because of "a sustained political emphasis on the need for the FSA to be 'light touch' in its approach and mindful of London's competitive position".

Had regulators been harder on the bankers, "it is almost certain that their proposals would have been met by extensive complaints that the FSA was pursuing a heavy-handed, gold-plating approach which would harm London's competitiveness".

As all British taxpayers know by now, securing the "competitiveness" of RBS has wound up costing us around £45bn. So what is it that justifies the kid-glove treatment of the finance sector?

Switch on the news and you normally hear some minister or lobbyist (come on down, Angela Knight of the British Bankers' Association) talking about the vital contribution banking makes to employment. Our tax revenue. Or the role banks ideally play in directing money to needy businesses.

These claims are repeated so often that they rarely get even the briefest patdown from interviewers, let alone backbench MPs or economists. Yet they are largely bogus, as explained in a new book called After the Great Complacence, produced by academics at Manchester University's Centre for Research on Socio-Cultural Change (Cresc). Indeed, on nearly any important measure, finance actually contributes less to Britain than manufacturing.

Take jobs. The finance sector employs 1m people in Britain. Chuck in the lawyers, the PRs and the smaller fry that swim in its wake and you are up to a grand total of 1.5m. And most of these people are not the investment bankers for whom Cameron went to war in Brussels.

At the big British banks such as RBS and HBOS, 80% of the staff work in the retail business. Even if Sarkozy were to shroud Canary Wharf in a giant tricolore, those staff would still be needed to staff the branches and man the call centres. Even in its current state of emaciation, manufacturing employs 2m people.

What about taxes? Lobbyists like to point out that banks are usually the biggest payers of corporation tax, but usually omit to mention that corporation tax isn't that big a money-spinner. For their part, even leftwingers will usually assume that the bankers effectively paid for the tax credits, hospitals and schools we enjoyed under Labour.

It's not true. The Cresc team totted up the taxes paid by the finance sector between 2002 and 2008, the six years in which the City was having an almighty boom: at £193bn, it's still only getting on for half the £378bn paid by manufacturing. It would be more accurate to say that the widget-makers of the Midlands paid for Tony Blair's welfarism. But that would be a much less picturesque description.

Even in the best of times, the finance sector hasn't paid anything like as much to the state as the state has had to pay for them since the great crash. According to the IMF, British taxpayers have shelled out £289bn in "direct upfront financing" to prop up the banks since 2008. Add in the various government loans and underwriting, and taxpayers are on the hook for £1.19tn.

Seen that way the City looks less like a goose that lays golden eggs, and more like an unruly pigeon that leaves one hell of a mess for others to clear up.

Ah, but what about lending? After all, this is why we have banks in the first place: to channel money to productive industries. The Cresc team looked at Bank of England figures on bank and building society loans and found that at the height of the bubble in 2007, around 40% or more of all bank and building society lending was on residential or commercial property.

Another 25% of all bank lending went to financial intermediaries. In other words, about two-thirds of all bank lending in 2007 went to pumping up the bubble.

This doesn't look like a hard-working part of an economy humming along: it's nothing less than epic capitalist onanism. If the statistics don't support the arguments for the City's pre-eminence, the public don't either. In 1983, 90% of the public agreed that banks in Britain were well run, according to the British Social Attitudes survey. By 2009, that had plunged to 19%.

In other words, both the evidence and the voters are against investment bankers. So why do the politicians cling on to them?

Part of the answer is financial. Bankers used the boom to buy themselves influence – so that, according to the Bureau of Investigative Journalism, the City now provides half of all Tory party funds. That is up from just 25% only five years ago.

Another part must be cultural. Running this government are two sons of bankers. Cameron's father was a stockbroker, Clegg's is still chairman of United Trust Bank (and famously helped his son get some work experience). For its part, Labour spent so long outsourcing all economic thinking to Gordon Brown and Ed Balls that it has long lost the ability to argue against the orthodoxy of giving the City what it wants.

In a poorer country, the cosiness of relations between bankers and politicians would be scrutinised by an official from the World Bank and disdainfully pronounced as pure cronyism. In Britain, we need to come up with a new word for this type of dysfunctional capitalism – where banks neither lend nor pay their way in taxes, yet retain a stranglehold on policy-making. We could try bankocracy: ruled by the banks, for the banks.

What are the results of bankocracy? It means that the main figures arguing for a Robin Hood tax are the Archbishop of Canterbury Rowan Williams and Bill Nighy. It means that opposition to the rule of banks isn't found in Westminster, but in tents outside St Paul's or among a few grizzled academics and NGO-hands – with no political vehicle to carry them. Meanwhile, the politicians declare that the national interest of Britain can be defined by what suits one square mile of it.

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Legal Problems Seen for EU Deal
by Matina Stevis and Frances Robinson - Wall Street Journal

Senior European officials said Tuesday it could be difficult to convert last week's political deal among European Union member states into a watertight legal pact, signaling a fresh concern about the region's latest response to the debt crisis.

In remarks to the European Parliament in Strasbourg, European Council President Herman Van Rompuy said the fact that the U.K. had vetoed an EU-wide agreement, forcing member states to sign a separate intergovernmental accord, would complicate the task of implementing new, stricter fiscal rules.

"An intergovernmental treaty was not my first preference, nor that of the most of the member states ... It will not be easy, also legally speaking. I count on everybody to be constructive bearing in mind what is at stake," he said.

A potential weakness of an intergovernmental agreement is that it could be easier to unravel legally. It may also not be easy to achieve either, with some EU member states that don't use the euro already indicating they may seek different terms than euro-zone members.

"We must continue to evaluate what it is that has been agreed. It is clear that Sweden will not enter this cooperation on the same terms as euro-zone members," Swedish Finance Minister Anders Borg told reporters in Stockholm Tuesday.

Sweden doesn't use the euro so will have "another role," Mr. Borg said. "It's not completely clear what situation faces countries like Denmark, Poland and Sweden which are not euro members."

The Czech government also said Tuesday that it needs to see details of the deal before it can commit to it. Czech Prime Minister Petr Necas said the euro zone and its leaders can't set a deadline by which noneuro-zone countries must make a decision on two "very serious" issues.

At the summit, EU leaders agreed to tighten control over the budgets of the 17 euro-zone members, a measure that may also be adopted by all other EU members with the exception of the U.K. They also agreed to channel as much as €200 billion to the International Monetary Fund, with about a fourth of the funds coming from noneuro-zone countries, to help fund its backstop mechanisms. But they put off till March a decision on raising the €500 billion cap on resources of the permanent euro-zone bailout fund.

Euro-zone borrowing costs have risen again this week and stock markets came under pressure after an initial relief rally on last week's summit deal faded. Among investor concerns was the region's failure to complete the work on a powerful financial firewall to stem the debt crisis. Some were also disappointed by European Central Bank President Mario Draghi's refusal to give an explicit promise that the bank would intervene more boldly in bond markets in exchange for the promised fiscal reforms.

Mr. Van Rompuy said Britain's position meant "there was no alternative" to agreeing a treaty among the euro zone members plus any noneuro countries that wish to join. And he said the breadth of support from EU member states for the accord made him optimistic a way will be found to enforce the deal. "I'm optimistic because I know it is going to be very close to 27, in fact 26 leaders indicated their interest," he said.

In the early hours of the morning last Friday, U.K. Prime Minister David Cameron decided to block changes to the treaty after other EU heads of government meeting at a summit in Brussels refused to give Britain an effective veto over future financial regulation initiatives.

Much of the three-hour debate turned into a verbal joust over David Cameron's decision to block the new fiscal rules being enshrined by changing the current Lisbon treaty. Mr. Cameron's decision also came under fire from Sharon Bowles, one of the most influential members of the U.K.'s Liberal Democrats in the European Parliament. The Lib Dems are the junior coalition partners with Mr. Cameron's Conservatives.

She accused Mr. Cameron of a "power grab" and said while the Conservative leaders pre-summit promises "many have fooled" some Liberal Democrats in London, "it didn't fool us—or me."

Mr. Van Rompuy and European Commission President Jose Manuel Barroso were careful in not criticizing the U.K. too harshly. Mr. Barroso said it was impossible for the other euro zone members to agree to the U.K. demands which represented "a risk to the integrity of the single market." But he insisted the Commission and the other EU institutions will continue to protect the interests of all its 27 member states equally, "including those of the U.K."

Mr. Barroso also confirmed the commission tabled a compromise protocol during last week's talks, which would have given some protection to the U.K. But he said "unfortunately, this compromise proved impossible."

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Greece, Private Creditors At Odds Over 50% Haircut
by Costas Paris - Dow Jones Newswires

-Greece, Private Creditors Disagree On Coupon On New Bonds, Guarantees:
-Chinese Funds Reluctant To Participate In Haircut
-Needed 90% Participation By Private Creditors "Looks Difficult" To Achieve
-Talks Unlikely To Be Concluded Before February

The Greek government is at odds with its private creditors over a 50% haircut in the value of bonds they own, two people with direct knowledge of the negotiations said Tuesday.

The government is offering about half the coupon on new bonds that creditors are demanding, and some funds are reluctant to accept a haircut of the needed size, the two people said. "At this point there is no convergence. There are disagreements over the coupon and the guarantees sought by the creditors. There is also reluctance by some funds to participate, which means talks could stretch to February instead of the original plan to wrap everything up in January," one of those people told Dow Jones Newswires.

Greek Finance Minister Evangelos Venizelos met Monday with Charles Dallara, the head of the Institute of International Finance (IIF)--a trade body of the world's largest banks which is leading the talks--and officials from Greece's public debt management agency have been separately meeting with private creditors since last month.

The haircut is an integral part of an €130 billion second bailout package for Greece that will keep it from defaulting on its debts. If an agreement is reached, about EUR200 billion in debt held by private investors will by cut by half.

Greece has proposed a debt exchange under which investors would swap old government bonds for new ones worth 35% of their old face value, and with a coupon of around 4-5%. It is also throwing in a one-off cash payment equal to about 15% of the old bonds' value as an enticement, totaling around €30 billion.

The IIF has proposed a swap trading old bonds for new ones with a 50% lower face value, and is demanding a coupon of around 8%, plus guarantees for the principal of the new bonds estimated at around EUR30 billion. Those guarantees could come from a euro-zone body like the European Financial Stability Facility, the group's emergency bailout fund. For the exercise to be successful more than 90% of the institutions holding Greek bonds must participate in the deal.

A second person said Chinese funds holding "a significant amount" in Greek bonds are unwilling to participate as they consider themselves state entities and believe they should be treated like the European Central Bank, which is entitled to full repayment plus the coupon when bonds mature. Some hedge funds are also refusing to take part in the talks.

"The refusal of some financial institutions to participate complicates things," the second person said. "If the needed participation is not achieved the whole exercise is up in the air and the money has to be found from somewhere else."

He added that Germany's so-called "bad banks," which have come under state control and which had previously agreed to participate in a 21% write down, "are also uncomfortable with a 50% cut, but we expect that under pressure from Berlin they will eventually join in."

With a successful private sector involvement, the Greek government expects to save €5.1 billion in interest payments alone next year. The first person said that if the participation falls short, there are thoughts in Athens and the euro-zone about triggering the so-called "collective action clauses" that would force haircut on all creditors provided that around 75% agree to participate.

"Something like this will likely be seen as a credit event and trigger credit default swaps which nobody in the euro zone wants. However, both Athens and the euro-zone are determined to achieve the necessary participation," he said.

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Greek budget hole widens, targets tougher to reach
by Ingrid Melander and Harry Papachristou - Reuters

* Central govt budget gap grows 5.1 pct y/y in Jan-Nov
* Construction down 38 pct in January-August
* Greece likely to miss 2011 budget deficit target
* Greece borrowing costs increase in T-bill auction

Greece's yawning public deficit widened in the first 11 months of the year, putting budget targets further out of reach, while building activity plunged by more than a third since the start of the year, data on Tuesday showed.

With international officials and bankers in Athens to work on details of a new 130 billion euro bailout package, the data underlined the stark challenge facing the technocrat government of former central banker Lucas Papademos.

"The recession will be deeper than the government and the troika are expecting," Capital Economics analyst Ben May said, referring to the joint inspection team from the European Union, European Central Bank and International Monetary Fund .

"Greece will struggle to reduce its budget deficit and will come under more pressure for austerity. There is certainly a risk that Greece may well come to the point it decides it might be best to default," he said.

Choking on debt amounting to 160 percent of gross domestic product and forecast to enter its fifth year of recession in 2012, Greece's weakened economy is staggering under the repeated doses of austerity prescribed by its international lenders.

Finance ministry data on Tuesday showed the budget gap of the central government widened 5.1 percent to 20.52 billion euros ($27.1 billion) in the first 11 months of the year.

The data suggests Greece could miss its target of cutting the deficit to 9 percent of GDP from 10.6 percent last year and may force the government to impose additional austerity measures to catch up with its budget goals in 2012.

Greece and its international lenders expect the economy to shrink by at least 5.5 percent this year and bleak construction data showed on Tuesday that a deep slump continued in what was a key driver of the country's growth when it joined the euro and organised the 2004 Olympics. Building activity by volume contracted 37.8 percent in the year to August while the number of new building permits dropped by 30.6 percent.

Taxes
As inspectors from the EU/ECB/IMF troika combed through the books in Athens, private bondholders, also meeting in the Greek capital, failed to agree with the government on the outline of a bond swap that is part of the deal, and agreed to continue consultations.

This year's budget goals largely hinge on a string of emergency taxes imposed in September after Greece's lenders threatened to withhold bailout funds if it did not meet its budget goals. The recession has since cancelled out much of the extra revenues the government was hoping to raise.

With the year almost over, the finance ministry insisted that the 2011 budget target was still on track, despite the wider deficit figure reported on Tuesday. "The current revenue shortfall is expected to be addressed in December, when (emergency) tax measures will yield results," it said in the statement.

But a senior government official was less optimistic. "If current spending and revenue trends continue, the deficit will be at about 10 percent of GDP and not at about 9 percent," the official, who declined to be named, told Reuters before Tuesday's budget data were announced.

The new taxes included a charge of up to 5 percent on gross personal income as well as a controversial property tax which households must pay or face having their electricity cut off. These measures have failed to boost net tax receipts, which shrank 3.1 percent year-on-year in Jan-Nov, a slightly slower pace than a 4.1 percent drop in the first 10 months of the year.

Recession is dealing a further blow to the budget as the government steps up grants to social security organisations, whose revenues are drying up. Spending before interest payments rose by 3.0 percent year-on-year in Jan-Nov. The data refer to the state budget deficit, which excludes items such as local authorities.

Even though they are not identical, they are indicative of the general government shortfall, the benchmark for the EU's assessment of Greece's economic policy programme. Greece had to pay a higher price to sell T-bills on Tuesday, when the debt management agency sold 1.625 billion euros of six-month T-bills but saw the yield rise by 6 basis points to 4.95 percent from a previous auction in November.

Monthly T-bill sales have been Greece's sole source of market funding since it was shut out of bond markets early last year when its derailed finances triggered the country's worst crisis in decades. The country's cash deficit decreased slightly in the first 11 months of the year to 20.24 billion euros from 21.38 billion in the same period 2010, central bank data showed, largely thanks to privatisation receipts.

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IMF slashes growth forecast for Greece
by Larry Elliott - Guardian

IMF report likely to fan financial market fears over debt default as Greece struggles to cope with austerity and recession

The International Monetary Fund slashed its growth forecasts for Greece and warned that ever-deepening recession was making it harder for the debt-ridden country to meet the tough deficit reduction targets under its austerity programme.

In a report likely to fan financial market concerns about a possible debt default, the regular health check by staff at the Washington-based Fund said the situation in Greece had "taken a turn for the worse".

Poul Thomsen, deputy director of the IMF's European department and its mission chief to Greece, said: "We have revised growth down significantly to -6% in 2011 and -3% in 2012. We expected 2011 to be an inflection point when the recession bottomed out, followed by a slow recovery. But the economy is continuing to trend downwards. The hoped for improvement in market sentiment and in the investment climate has not materialised."

The IMF, together with the European Union and the European Central Bank has imposed tough conditions on Greece as the price of financial support that has allowed the government in Athens to continue paying its bills. In the fifth report carried out since the start of the crisis 18 months ago, IMF officials suggested that the austerity programme might need to be eased in view of the damage being caused to the economy by the recession.

"Discussions [at the IMF] focused on recalibrating the programme's macroeconomic framework and adapting the implementation of reform and adjustment policies to an appropriate and feasible pace."

The IMF had previously assumed that the contraction in the economy would be limited to 4.5% this year, allowing the budget deficit to be trimmed to 7.5% of gross domestic product. Thomsen said the deficit was likely to be 9% of national output this year.

However, Greek officials are privately saying that the budget black hole is likely to be "in excess of 10%", making the imposition of yet more austerity measures inevitable. "Pay cuts have only made the recession worse," one source said.

The IMF report added that market sentiment had "steadily deteriorated, with 16.5% of bank deposits withdrawn since the end of 2010". Since the start of the recession, the economy has contracted by 15%. It has also suffered losses of more than €60bn (£50.5bn) in tax avoidance.

In talks with Evangelos Venizelos, the finance minister, international inspectors urged the authorities to streamline the bloated public sector by both closing state organisations and putting 30,000 civil servants into a special "labour reserve".

Opening up several "closed professions", which are often blamed for the country's notorious lack of competitiveness, has also been suggested. The social implications, however, of further belt-tightening on a populace now stretched to the limit by a barrage of tax increases, wage and pension cuts could be immense.

The report said IMF staff believed that the new Greek government, headed by Lucas Papademos, was committed to the austerity programme. "The authorities have taken steps to bring the fiscal programme back on track, taking meaningful measures to cut public wages, employment and pensions, and to broaden the tax base (prior actions)."

"Still, risks to the programme remain large, both from external sources (the worsening outlook for the euro area), and internal sources (a relapse into weak implementation)." The Fund explained that there was a "growing risk" that the outcome for Greece would be even worse than envisaged, especially if structural reforms were delayed.

"Accelerated private sector adjustment, on top of fiscal retrenchment, would likely lead to a downward spiral of fiscal austerity, falling disposable incomes and depressed sentiment. In effect, the economy would rapidly work off its external imbalance through deeper recession and wage-price corrections rather than through productivity enhancing structural reforms."

In its analysis, the IMF said Greece's debts were still sustainable even with the gloomier economic backdrop, but only if the country's private sector creditors accepted a writedown of 50% and Athens received financial support on favourable terms. "The previous 21 July financing package would not work. Public debt would peak at 187% of GDP in 2013 and fall to 152% of GDP by 2020. Net external debt would peak at 128% of GDP in 2012 and fall to 96% of GDP by 2020. These already weak downward trajectories would not be robust to shocks.

"Further progress in reducing the deficit is going to be hard to achieve without underlying structural fiscal reforms. Greece will not be able to undertake – in a socially acceptable manner – the large fiscal consolidation that still lies ahead without a much stronger resolve to tackle the problem of tax evasion."

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Rapid rise in Arctic methane shocks scientists
by Steve Connor - Independent

Dramatic and unprecedented plumes of methane - a greenhouse gas 20 times more potent than carbon dioxide - have been seen bubbling to the surface of the Arctic Ocean by scientists undertaking an extensive survey of the region.

The scale and volume of the methane release has astonished the head of the Russian research team who has been surveying the seabed of the East Siberian Arctic Shelf off northern Russia for nearly 20 years.

In an exclusive interview with the Independent, Dr Igor Semiletov, of the Far Eastern branch of the Russian Academy of Sciences, said that he had never before witnessed the scale and force of the methane being released from beneath the Arctic seabed.

"Earlier, we found torch-like structures like this but they were only tens of metres in diameter. This is the first time that we've found continuous, powerful and impressive seeping structures, more than 1000m in diameter. It's amazing," Semiletov said. "I was most impressed by the sheer scale and high density of the plumes. Over a relatively small area, we found more than 100 but, over a wider area, there should be thousands."

Scientists estimate that there are hundreds of millions of tonnes of methane gas locked away beneath the Arctic permafrost, which extends from the mainland into the seabed of the relatively shallow sea of the East Siberian Arctic Shelf.

One of the greatest fears is that with the disappearance of the Arctic sea-ice in summer, and rapidly rising temperatures across the entire region, which are already melting the Siberian permafrost, the trapped methane could be suddenly released into the atmosphere, leading to rapid and severe climate change.

Semiletov's team published a study last year estimating that the methane emissions from this region were about 8 million tonnes a year, but the latest expedition suggests this is a significant underestimate of the phenomenon.

In late northern summer, the Russian research vessel Academician Lavrentiev conducted an extensive survey of about 25,900sq km of sea off the East Siberian coast. Scientists deployed four highly sensitive instruments, seismic and acoustic, to monitor the "fountains" - or plumes - of methane bubbles rising to the sea surface from beneath the seabed.

"In a very small area, less than [25,900sq km], we have counted more than 100 fountains, or torch-like structures, bubbling through the water column and injected directly into the atmosphere from the seabed," Semiletov said.

"We carried out checks at about 115 stationary points and discovered methane fields of a fantastic scale - I think on a scale not seen before. Some plumes were 1km or more wide and the emissions went directly into the atmosphere - the concentration was 100 times higher than normal." Semiletov released his findings for the first time last week at the American Geophysical Union meeting in San Francisco.

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