Binge borrowers

Steve Bundred, chief executive of the Audit Commission, has written in today's Times on the subject of government borrowing. He won't have won any friends in Downing Street by what he has said:

Most economists and ministers now believe that a prudent fiscal policy means not allowing public sector debt to exceed 40 per cent of GDP. But the Government is under no obligation to manage the public finances with this target in mind. Indeed, Britain is not even bound by the 60 per cent limit in the Maastricht treaty, as Margaret Thatcher managed to win an opt-out from the relevant article.

This is just as well, given what has happened since last year. With the debts of the nationalised and part-nationalised banks now on the public sector balance sheet, the ratio of public sector debt to GDP in the UK exceeds that of Italy and Japan. And it is set to grow much higher. On the basis of the planned levels of borrowing, it could exceed 65 per cent of GDP in 2010-11.

And at that scale of indebtedness, the Armageddon scenario most feared by the Treasury - that there will be insufficient lenders to match the planned level of borrowing - begins to look a distinct possibility.

That is why tax increases and spending cuts are inevitable immediately after the election, assuming that there are signs of economic recovery by then - and why any managers of a public service who are not planning now on the basis that they will have substantially less money to spend in two years time are living in cloud-cuckoo-land.

Encouraging it isn't. You may think that any Chancellor or Prime Minister who presided over failure on this level should lose his pension.

You can read the full article here.

Help in testing times

The current economic difficulties will add to the already large number of people in the UK who are entitled to claim state benefits but fail to do so, or at least miss out on some of the help that is due to them.

If you know anyone that may be in this position, send them along to entitledto.com - an independently run website that has been offering benefits calculators since 2000.

The site may just provide the help one of your friends or relatives needs to make their life easier.

Can bonuses work?

Robert Peston has published a thoughtful piece today on the bonus culture for bankers.

The problem with bonuses arises where people are paid hefty sums to reward what initially looks like success - selling bucketloads of new mortgages, for example - but later turns sour, when the mortgage holders can't keep up their payments. By then it's too late: the bankers have pocketed their bonus and the bank's shareholders end up with the losses.

Peston suggests that:

A genuine reform of the bonus-culture, one that would really put the kibosh on bankers taking foolish risks, would re-introduce the concept of the "malus" - or the idea that when a firm does badly, or a deal goes bad, the partners (in this case the de-facto partners, the top executives) take a hit and suffer a permanent diminution of wealth.

An interesting idea, but a difficult one to accomplish. You can read Peston's thoughts in full here.

A bonus scheme for employees or executives is a great idea when it encourages work that generates more profits for the business in the medium to long term. But instead it usually focuses behaviour on actions that generate bonuses for the employee now; that's not necessarily the same thing as bringing long term benefits to the business. In hitting their target they can incur bad debts, service quality could be reduced or other problems may follow.

The way to avoid this with a bonus scheme is to align the interests of the employees with those of the business owners. It appears that this has been achieved with the John Lewis Partnership model, but not many business owners seem to want to adopt that route. Employee share ownership plans may also work - these are best for listed companies - as may payment of a straight profit share. But it's difficult to target them on outstanding contributions by particular individuals rather than paying out across the board to all employees.

BBC Radio 4 has a programme, More or Less - currently off the air - which in its last series looked at a bankers' bonus question. So many listeners challenged the answer that they added the following explanation to their website:

A trader enters a bank where everyone else is doing exactly the same trade and that trade has a 50% chance of making a profit. The trader knows of a trade that has a 75% chance of making a profit.

But in order for the individual trader to get his bonus, two things have to happen: the bank has to make a profit and the individual trader has to make a profit.

If the trader does his good trade, the probability of him getting his bonus is the chance of his trade making a profit - ie 75% - multiplied by the chance of the bank making a profit - ie 50%.

His chance of getting a bonus is therefore 37.5%. However if he does the same as everyone else, his chance of getting a bonus is 50%.

Some listeners asked why the trader's chance of making a profit if he did the same trade as everyone else was not 25% (ie 50% x 50%).

The answer is that the 50 per cent strategy is perfectly correlated with the bank's profitability, while the 75 per cent strategy is perfectly uncorrelated.

When the probabilities are perfectly uncorrelated, 75% x 50% is the right calculation to work out if the trader gets his bonus.

When the strategies are perfectly correlated, either both the trader and the bank make money, or neither the trader nor the bank make money.

Make sense to you? Me neither. It just goes to show how any bonus scheme can have unexpected and unintended consequences. I am sometimes asked to help design bonus schemes for businesses. I think that basic pay linked to performance through regular appraisals works better.

Tax doesn't have to be taxing

...or so HMRC's intensely annoying TV commercials tell us.

It is of course; filling in a tax return is a huge imposition. But I thought we had it bad until I read about the US equivalent. The information this demands goes way beyond the reasonable.

For example:

"...the IRS wants to know where I was and what I was doing on every day last year, state by state and country by country."

More about this here. Maybe ours isn't so bad after all.

Oh Mandy...

The depth of concerns within the government over perceptions of the UK economy were revealed yesterday when Lord Mandelson spoke out at a diplomatic reception in New York. Diplomatic? Yeah, right.

Responding to a question about comments made by Howard Schultz, the head of Starbucks - who had said he thought Britain was in an economic spiral - Mandelson responded:

"Why should I have this guy running down the country? Who the f**k is he? How the hell are they [Starbucks] doing?"

Full details of the story can be seen in the Guardian and Telegraph.

Have to say, I'm not altogether sure that this sort of outburst helps, even if it does make the Secretary of State feel better.

Regulators, whistle blowers and Gordon Brown

The links between the regulators, the banks and the Prime Minister keep emerging.

Today, Nick Drew over at the Capitalists@Work blog has another tale of what, as he says, Nick Robinson has called the City merry-go-round.

Take a look at this.

Messy world, eh?

It's probably not as bad as we think

At the end of the week which saw Parliament stage show trials of Britain's bankers and then subject Gordon Brown to polite questioning, it's as well to remember that the current dreadful economic conditions won't last forever.

The first obvious sign of our current problems was the large debt write-off made by HSBC in early 2007 - yes, nearly two years ago. The current recession will probably last until late this year, then business will again start to grow.

It's always in the 'start to grow' stage that life can become particularly painful for businesses who find they need to finance rising working capital after a period in which their cash resources and borrowing capacity have been eroded.

But it is well to remember that, as the Economist says today:

"just as there was too much optimism during the good times, so there can be too much pessimism in the bad times".

Pessimism is certainly not in short supply just at the moment, but most businesses will survive, most workers will retain their jobs and at some point we'll start to feel confident about the future.

There's a lot of shouty columnists and bloggers depressing us all, but today's Economist article, Britain's fallen star does provide a comprehensive and balanced view of where we stand and is worth a read.

Oh and if you're reading this in time, don't forget Valentine's Day, or you could face something far worse than a recession.

New media meets new business?

I like the idea of this.

Mark Cuban - an American billionaire entrepreneur - wants business ideas that he can back as a way to help restart the US economy.

Only three days since the idea was put forward, there's already a good number of serious responses - with, no doubt, plenty more to come.

Would you want to publish your business plan online for others to criticise or 'borrow'? Would you do it if there was a realistic chance that someone would back your scheme? There must be many people - especially now - with business ideas for which they cannot get any backing. Maybe this idea should be taken up in the UK, too.

Time to feed the pig?

At a time when our government is encouraging us to borrow and spend - which helped put us in this mess in the first place - the major US accountants organisation the AICPA is running a media campaign urging Americans in the key 25-34 age range to 'spend carefully and save for the future'.

“People in this age group are involved in major life changes,” said Carl George, chair of the National CPA Financial Literacy Commission. “They’re launching careers, buying homes, getting married and having children. All these events involve major expenses, which makes saving difficult, especially in a hard economic time like the one we’re now experiencing. But there are simple things they can do, such as paying more attention to how much they spend on discretionary items. Spending within your means is itself a form of saving.”

At a time when half the world - China, Gernamy, the middle East and others - need to spend more while we in the UK and the USA (to name just two) have to scale back their spending and start to save, this is probably good advice. And delivered in a fairly unconventional way.

Take a look at Feedthepig.