Why you shouldn't base a business-model on bubble values (part 94)

From The Times:

British Midland (bmi) may struggle to raise the £95 million in funding it needs to keep flying because potential buyers for its Heathrow landing slots have become thin on the ground...

In the airline’s most recent accounts, its directors warned that uncertainty over the slot sale cast doubt on the company’s ability to continue as a going concern next year. This has sparked fears about the future of the UK’s third-largest airline and Heathrow’s second-largest operator...

Bmi’s most valuable asset has been its 11 per cent of Heathrow landing slots. The airport has been so congested in the past that slots traded for huge sums of money. Continental Airlines paid $209 million for four pairs of slots two years ago, but today recession-hit carriers are cutting back rather than seeking to expand.

Until UK airports and British Airways were privatised about twenty years ago, nobody paid much attention to the inherent value of landing slots. The government of the time just handed over most of the slots to British Airways, rather than parcelling them up with the airports or the sensible option, retaining them as part of the state's assets.

Commonsense, and real life, tells us that the value of the slots is a balancing figure, i.e. the money an airline can earn from each flight minus its normal operating costs. The normal operating costs can be competed away so are a fairly stable figure but total ticket sales fluctuate a lot depending on current economic conditions (and/or fear of terrorist attacks), so the value of the slots fluctuates disproportionately.

What exacerbates the fluctuations is that slots are a semi-artifically rationed monopoly right (the only way to increase supply is to buil more airports, and the NIMBYs aren't having that, of course), which enhances their value even more. And the net present value is inversely proportional to prevailing borrowing rates. In other words, the value of the slots is a function of the super-profits that airlines can earn, and then some.

These value fluctuations don't affect those airlines who originally got the slots for free (and haven't used them as security for loans), but airlines who borrowed money to buy them are now in big trouble.

Would it not have been better for the state to take the sensible option, retain the slots and auction them off each year or every six months? The airlines would never bid anymore than next year's super-profits, so would never have been able to get into such debts; in bad years, the price will be bid down, so in the bad years airlines save money and still remain profitable.

The auction proceeds could be used to pay for the external costs of air travel in places round airports, i.e. noise pollution, extra congestion on roads and railway etc. Or to put it crudely, bribe local NIMBYs into accepting that collectively, we are better off with airports than without them.

What's not to like?

"David Dimbleby injured by bullock"

Over at the BBC.

The 71-year-old was loading a bullock onto a trailer at his farm in Sussex when it reared, resulting in the presenter being briefly knocked out...

Thanks to AC1 for emailing me this.

"Police get 93-page guide to cycling"

Over at The Metro. Enjoy.

Economics Thought Experiment Of The Day

One idea espoused by more rabid free-marketeers when discussing the banking system is the idea that banks should/should be able to issue their own currencies, e.g. as suggested by Financial Services Minister Lola in the comments to one of yesterday's posts:

Returning to commercial banks the right to issue their own currency would make them more 'prudent' and to switch from gaining deposits on 'rate' to gaining deposits on 'security'.

1. I always find it helpful, before we reinvent the wheel or propose something radical, to look at what actually happens. If you think about it, commercial banks can and do issue their own currencies when they raise money by issuing bonds (which historically are a far more important source of funding that issuing shares). The following does not really apply when a bank raises money by taking ordinary bank deposits.

2. The main practical difference between two different currencies are that they pay different interest rates (for a variety of reasons the relevant one, for the purposes of this discussion being the fact that some countries are better or worse credit risks); and that their relative values fluctuate, i.e. EUR 100 a year or two ago was worth GBP 60 and now it's worth GBP 90.

3. If a good bank like HSBC and a shit one like Lloyds Group both issue bonds for GBP 100 nominal value next week, the market value of each, on the date of issue will be close to GBP 100. But Lloyds Group's bonds will have to pay a much higher interest rate than HSBC's because they are, at present, a worse credit risk.

4. If Lloyds Group's credit rating tanks even further, the market value of all their bonds in issue will go down; if it recovers, the value will go up, and if the interest rate is high enough, the market value will go above nominal value. So you might pay GBP 100 for GBP 100 nominal next week and be able to sell them on for GBP 110 in a few months or a year's time.

5. So, somebody who invests in the bonds issued by a UK bank that are denominated in GBP, is to all intents and purposes investing in a (slightly) different currency to GBP. As and when the holder wants to convert his nominal GBP 100 of bonds back into hard cash, coins and notes, in the future, he will find that the market value could be anything between GBP 0 (if the bank has lost a lot of money and the bonds are 'junior' or unsecured debt) and a lot more than GBP 100* (if the banks credit rating is good/has improved and/or the interest rate is higher than future interest rates on similar quality bonds).

6. That's exactly the same as investing in bonds issued by a foreign government; if you invest GBP 100 today, the amount that you get back in hard cash in future will go up or down, depending on how that country's economy is doing, how high government debt is, how high their interest rates are in future and so on.

Just sayin', is all.

* For comparison, some building society 'Permanent interest bearing shares' that were issued when interest rates were very high, and which still pay 13% interest are worth about 150% of nominal value, even those issued by wrecks such as Halifax (now part of Lloyds Group)

Economic Myth Of The Day

From The Torygraph:

"[Mortgage] Lenders, as a whole, do not have enough funding for mortgages to help promote the economic activity that will help lift the UK out of recession."

The article was posted on the HPC Blog, and I commented thusly:

"... why is there this general perception that mortgage lending stimulates the economy?

All it does is mean that more borrowers are paying more interest to more depositors. If the depositors are from abroad, then interest payments are going abroad, which reduces the money we can spend. If it is all domestic, then it's a break even at best, and probably mildly negative (more people working in banks shuffling paper etc)."

There are so many things you can spend money on, you can invest in your education; a business can invest in market research, product development, plant and machinery, staff training and advertising; people could withdraw money and invest in new shares, enabling companies to repay borrowings (thus helping to deflate the credit bubble in an orderly fashion); heck, people could withdraw their money and spend it (remembering that businesses vastly prefer £1 income to £1 loan). All of these things stimulate the economy, or put it on a sounder footing.

There are very few things you can do with money that do not stimulate the economy, but borrowing to the eyeballs to bid up house prices again is certainly one of them. Even physically burning money is better for the economy, as it is like cancelling government debts, so lifting the future tax burden a bit.

Answers on a postcard.

Fun Online Poll Results: What are we missing?

Last weekend's Fun Online Poll asked "Which is the better way to help businesses?". I normally wait until a hundred people have voted, but so far 73 have chose "Cut Taxes" and nobody has chosen "Bail out the banks, in the hope they'll increase lending", so I'm going to call it early.

Which begs the question, why on earth does our government insist on bailing out the banks time and time again? I would assume that this is a desperate measure to prop up house prices, or possibly because our government is so dumb they think that the banks are important, or maybe even because the members of this government are hoping for well-paid non-jobs with UK banks after they get voted out next year.

Sure, the existence of a banking system (payments, direct debits, cash machines) is vitally important, as is the general idea that banks match savings with borrowing to the mutual benefit of all concerned. But banks are just middlemen, and have very little capital of their own. So if one lot go out of business, the staff, the branches, computer networks etc are still there; and the savings and the mortgages are still there, so why not let somebody else come and have a go?

For a real life example, see the transfer of most of B&B's assets/liabilities to Santander a year ago. Sure, somebody has to face up to the losses (which are already there), but they can be divvied up between reckless borrowers, bondholders and shareholders, there's no point burying our heads in the sand.
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Moving on, this week's Fun Online Poll asks "What should income-related benefit withdrawal try to achieve?"

In case that sounds a bit technical, what I mean is the fact that somebody on Income Support etc loses £1 in benefits for every £1 he earns; and households on Tax Credits lose around 70p in Tax Credits/PAYE for every £1 they earn. Those are "income-related benefits withdrawal" rates of 100% and 70% respectively.

For a graphic representation of what I mean, see here.

Vote here or use the widget in the sidebar.

Yes, that's "Jane's", not "Janes", "James" or "Jones"

From Jane's

Responding to questions from committee members at an open hearing on 10 November, Sir Bill Jeffrey, the permanent under-secretary for the MoD [Ministry of Defence], said the department may need to write off a large proportion of expenses errors worth GBP268 million (USD448 million) gross, identified by a National Audit Office (NAO) report published in July.

The NAO's review of the MoD's 2008-09 report of accounts found that 14.7 per cent of transactions carried out using the MoD's Joint Personnel Administration (JPA) expenses system were in error. (The JPA handles specialist pay, allowances and expenses for MoD personnel.)

When asked what proportion of the GBP268 million may eventually need to be written off, Terrence Jagger, the MoD's director of financial management, said: "At an educated guess – I'd say considerably less than half of it. GBP268 million is the NAO's estimate of gross error," he added. "Those errors arise from situations where we can't provide satisfactory evidence ... . It may well prove that GBP268 million is an over estimate."

For comparison, there are about 146,000 soldiers in the British Army and one civil servant for every two serving armed force members.in the MoD. My trusty calculator tells me that the average expense overclaim per civil servant was about about £2,680 each in one year alone, but it would be enough to give every British soldier going to Afghanistan a bonus of about £10,000 each (assuming they change shifts three times a year). Or indeed to pay compensation of £500,000 to every seriously injured soldier.

Are we a Police State yet?

From The Metro:

A grandfather was arrested in a dawn raid and held in a police cell for six hours - for swearing once in front of a council official. Thomas Catcheside was woken at home by officers, marched to his bedroom - where his wife was still asleep - and ordered to get changed before being driven away in a police van.

The 67-year-old, who admits using the f-word in a row with the official, had his fingerprints and a DNA swab taken*, before being issued with an £80 fixed-penalty notice and released. 'I was frightened and angry. It was so heavy-handed,' said the former lorry driver.

His arrest followed a dispute a few days earlier over 'dangerously slippery' stairs in his communal block of flats in Cambridge. The grandfather-of-five, who is chairman of his local residents' group, has been campaigning for three years for safety improvements to the staircase. But when an official stopped him from following him downstairs to listen to a phone call to a supervisor, Mr Catcheside snapped: "Don't you tell me what I can and can't do in my own f***ing place."

A Cambridgeshire police spokeswoman said: 'We were responding to reports of an assault.'

1. As I've said before, one of the hallmarks of authoritarianism is that the punishment is inversely proportional to the offence, until ultimately any and every form of behaviour can be punished ("ThoughtCrime") on the say-so of a council official, police office or CPSO. "Fixed penalty notices" take us yet further down this slippery slope, as Simon Jenkins explained in yesterday's Evening Standard.

2. There is a separate offence of "wasting police time". Shouldn't the officers concerned be punished for wasting their own time?

* Which they can now retain for six years.

"Up to" of the week

From the BBC:

More than 300,000 families use them to save up to £2,400 a year through tax relief on the cost of childcare...

It involves parents sacrificing up to £243 of their salary - before tax and national insurance are taken off - in exchange for electronic "vouchers" which are then paid to Ofsted-registered child carers, from au pairs to nurseries. The Treasury wants to phase out this tax break, which is equivalent to a 31% saving on the first £243 spent on childcare costs each month for basic rate taxpayers, or 51% for those paying the higher rate.

So that really was lazy journalism - all the facts are there in the second paragraph, so you don't need to be a maths genius to work out that the absolute maximum tax/Employee's NI saving is 51% x £243 x 12 = £1,487 a year, and for a basic rate taxpayer it's £904, so saying "up to £2,400 a year" is either downright laziness or deliberately misleading.

The rest of the article is the usually blah, whine, moan special pleading - you must realise that a whole industry has grown up around administering the vouchers, which is exactly what was intended. Wouldn't it be far simpler to just stick an extra £20 a week on the cash-equivalent "nursery vouchers" (that are officially called something else, of course) and have done with it?

Petition Of The Week

Over at petitions.number10.gov.uk:

"We the undersigned petition the Prime Minister to stop referring to the EU as "Europe".

The European Union (EU) is not Europe. Europe is a continent containing many countries, most of which are in the EU. The EU does not cover the whole continent, it does not represent the whole of the continent and the British Government's Europe Minister doesn't form policy on the whole continent of Europe.

The Prime Minister, the British government and the EU itself should stop claiming the whole continent for the EU. The EU should not be referred to as "Europe" and the Europe Minister should be called the EU Minister. Similarly, the European Court of Justice and European Court of Human Rights should be known as the EU Court of Justice and the EU Court of Human Rights.

The Prime Minister should issue guidance on the use of the word "Europe", rename the Europe Minister to the EU Minister and petition the EU to name their institutions appropriately."

Via.