Jeremy Warner's Outlook: Are governments getting it right on bank bailouts?

WPP shifts tax domicile to Ireland; Bolton calls the bottom on stock markets
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The Independent Online

Should governments be buying up the banking system's bad debts, as proposed under the US Treasury Secretary Hank Paulson's $700bn bailout plan, or would not a better use of taxpayers' money be to recapitalise the banks with equity injections instead?

In both the US and Britain, policymakers have been pursuing the former course of action. By nationalising Northern Rock and the loan book of Bradford & Bingley, the Government has removed these unfundable lending portfolios from the system so they can be worked out in an orderly fashion over time. In America, the Paulson plan is in essence only an extension of what has already taken place with the nationalisation of Fannie Mae, Freddie Mac and AIG. In both cases, the effect is to remove illiquid assets from the system so they can be separately held to maturity or sold off in an orderly way. In theory, the rest of the system can start operating normally again once the crud has been removed.

Yet there is a growing band of dissent which thinks this approach is a waste of money, or at least that it needs to be supplemented with equity injections by governments. The argument is best put by the billionaire speculator George Soros. He points to one of the key flaws in the Paulson plan, which is that if the government pays too much for the debt, the taxpayer is likely to lose out. Yet if it pays too little, the banking system doesn't gain a lot of relief and still won't be able to att-ract the private equity needed to re-capitalise and lend effectively again.

As aired on these pages yesterday, Robert Talbut, the chief investment officer at Royal London Asset Man-agement, takes a similar view. For the banking system to start operating properly again, he thinks, requires the Government to back rights issues by British banks with taxpayers' money. Are they right? Personally, I cannot see how you can have one without the other. Nobody is going to recapitalise the banks until they know the debt problem has been removed. Several attempts have already been made at recapitalising the banks, both in the US and Britain, and in all cases equity holders have found themselves all but wiped out by subsequent further deterioration in the housing market.

The worst stuff has to be removed from the balance sheet first before there can be any question of further equity, either from governments or private investors. Otherwise it is just more money down the drain.

WPP shifts tax domicile to Ireland

WPP's announcement the other night that it is shifting its domicile to Ireland for tax reasons looks uncomfortably like one of those press releases snuck out while nobody was looking. With all eyes on Congress's apparently suicidal rejection of Mr Paulson's $700bn banking bailout plan, it was certainly a good day to bury the bad news. Not that Sir Martin Sorrell would necessarily accept that it is bad news. The WPP chief exec-utive reckons he will potentially save his shareholders £50m to £60m in tax by taking this action – or 10 per cent of earnings – and in any case, he has never made any secret of his intentions.

All the same, in a time of almost national emergency, and with public attitudes strongly polarised against money men and corporate tax avoidance, it is not going to play well to the gallery. At the very least, it looks un-patriotic. Sir Martin, who owes his knighthood to this Government and has just been confirmed as one of its "ambassadors for Britain", seems to be biting the hand that feeds him. Only 15 per cent of WPP's profits come from Britain these days, but the company's whole success was built on its British roots. Now it is to become part of corp-orate cyberspace, of no fixed abode and apparently responsible to nobody.

But nor is this just an impetuous, spur of the moment decision. The issues raised by WPP's actions are serious. A government desperate for tax revenue wherever it can find it seems to be deliberately targeting the foreign earnings of big multinationals such as WPP. After a public outcry by the CBI and others, the Treasury backed off to some degree and announced a review of the offending parts of corporate taxation.

Yet nobody in business has any faith that ministers mean what they say. With the Government heading for a £100bn deficit, anyone with cash will be squeezed until the pips squeak. For companies such as WPP, there is a real risk that the Government will attempt to claw back the £1bn it is losing on remitted foreign dividends with tax on foreign income. In any case, Sir Martin doesn't intend to take any chances.

All the same, this doesn't seem the right approach to me. Commercial decisions taken wholly for reasons of tax avoidance virtually always turn out to be flawed. At the very least, Sir Martin will lose his cachet with Gov-ernment, an important part of his calling card internationally. That may not matter much as in all likelihood we will have a new lot in shortly. By taking such action, Sir Martin might even bring the present Government to its senses.

Yet I suspect the quantifiable benefits to WPP will be at best marginal, and almost certainly outweighed by the less tangible downside. The truth is that we now live in a highly fungible world in which the opportunity for tax arbitrage between countries is not going to last very long, particularly within Europe. Taxes will be rising almost everywhere over the next few years – that much is certain after the enormity of the present banking bust. It is hard to see how Ireland, which has just guaranteed all its bank deposits to the tune of twice the value of GDP, can resist this trend. Where will WPP go when Ireland too becomes tax uncompetitive? Timbuktu?

There has to be an overwhelming advantage to a company to go through the administrative and other requirements of shifting domicile. Other than a few back-of-envelope calculations of what threatened but not yet enacted tax changes might do to the bottom line, WPP has failed to articulate precisely what this advantage might be. British corporate tax is a mess. There needs to be a proper national debate about how to make it relevant to a viciously competitive, 21st-century world. WPP should be playing its part in that debate.

Bolton calls the bottom on stock markets

Here are a couple of quotes from the late Sir John Templeton, the legendary money manager who died recently. One is that you should "always invest at the point of maximum pessimism". The other which may have relevance to our times is "buy while others are despondently selling and sell while others are greedily buying requires the greatest of fortitude and pays the greatest rewards".

So is now the point of maximum pessimism? One still active fund manager who seems to think so is Anthony Bolton, senior strategist at Fidelity. He is even backing his judgement with his own money. Followers of the sensational performance of his special situations fund will be swift to follow. He got the top of the stock market pretty much spot on and now he's calling the bottom. The big question i, is he calling it too early? Certainly, the mood among bankers is abject pessimism. Their world has been turned upside down and for them there is nothing left remarkable beneath the wandering moon. If you told them even the mighty HSBC was about to bite the dust, they would only shrug and shuffle along. Yet beyond financials and consumer-related companies, stock market performance both here and in the US hasn't been that bad. The FTSE 100 is less than 25 per cent off its June 2007 peak, which scarcely counts as a bear market. Strip out financials, property and retail and it might not be down at all. There have been much worse corrections. This sits oddly with what is widely being described as the worst financial crisis since the Great Depression.

Even so, Mr Bolton argues a good case. In his view, retail and other consumer stocks are beginning to discount a recession worse than that of the 1970s. Few are predicting that sort of a downturn, although obviously it could yet come to that if the banking system collapses. Personally, I've given up trying to predict the short-term gyrations of the stock market. It seems to me there is still plenty of scope for share prices to go lower still. Yet Mr Bolton must be right that, in any long-term view, there is already exceptional value out there.

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