Jeremy Warner's Outlook: Drama as Congress get 12 hours to save the world
Thursday 25 September 2008
Tora! Tora! Tora! In characteristically plain-talking fashion, Warren Buffett has likened the enormity of the banking crisis to an "economic Pearl Harbour". It's a nice analogy, conjuring up as it does the image of America asleep at the wheel, taken completely by surprise, under attack, and now fighting for its very survival.
Meanwhile, the US presidential candidates have cancelled their campaigns, so dire do they think the situation has become and urge the nation to rally behind the proposed $700bn Wall Street bailout. This may be more about political grandstanding than anything else, but it has certainly added to the air of crisis.
Ben Bernanke, the Federal Reserve chairman, has said America faces economic calamity if the bailout package is not passed as demanded by the weekend. It's scary stuff, as the credit crisis moves into its most dangerous phase yet.
Yet, despite the alarmist language, Mr Buffett seems to be calling the bottom by investing in Goldman Sachs,. The terms of the deal are extraordinarily generous to Mr Buffett, ranking him above all other equity holders and providing him with a sweet 10 per cent yield. This suggests that Goldman Sachs' need was rather greater than his. Still, better the home-grown Mr Buffett than a sovereign wealth fund or Japanese rival (Tora! Tora! Tora!) and in any case, money isn't really at the heart of it.
Rather it was Mr Buffett's stamp of approval which Goldman Sachs is after. If Mr Buffett thinks this is the time to back Goldman Sachs, still the most powerful franchise in what's left of the investment-banking scene, then perhaps others will too, allowing the vital process of confidence rebuilding to begin.
An exhausted-looking Hank Paulson, US Treasury Secretary, was back on Capitol Hill yesterday to persuade lawmakers to approve his $700bn bailout. Mr Buffett describes the package as "absolutely necessary to avoid going over the precipice". To Mr Bernanke's mind, it is essential law-makers drop their attempt to qualify the package. It's a quarter to midnight and if the proposals don't go through by the weekend catastrophe awaits. In the wake of the Lehman's collapse, the freeze in the money markets has got much worse with banks refusing to lend to each other because of worries about who might go under next.
So is it financial and economic Armageddon, or will catastrophe once more be averted? Yesterday evening's drama probably ensures the package will pass, and that in itself will help.
Nobody is saying that the bailout fund is the whole solution. That's going to require much more wide- ranging action in the field of banking consolidation, reform of accounting rules, recapitalisation of distressed banks, and so on. But it does seem to me to provide a reasonably sensible way out of immediate funding and solvency issues, indeed perhaps the only way out of them.
Much of the detail of how the scheme will work has yet to be adequately explained. What banks will qualify and which bad debts can be sold? What safeguards are there to ensure the taxpayer isn't paying over the odds? Congressmen are right to be concerned, given the amount of taxpayers' money at stake and the obvious political awkwardness of having to bail out the rich and powerful of Wall Street when socially more deserving causes are being left by the wayside.
Independent oversight is plainly essential to public confidence. Yet in most other respects, the workout vehicle proposed seems the right approach, and, in the circumstances, a relatively good use of taxpayers' money.
Against the cost of the Iraq war, which by some estimates has already exceeded $3trn, this is relatively small beer and certainly if it helps save the US economy much better value for money. The Iraq war has yielded no tangible benefits to the US whatsoever. To the contrary, by further destabilising the biggest oil-producing region in the world, it has contributed to high energy prices and thereby the current economic woes. The dangers of overpaying for assets in the Paulson plan ought to be solved by the "reverse auction" mechanism proposed, whereby debts are bought at the lowest prices tendered. Held to maturity, these debts ought then to repay the taxpayer in full, if not yield a profit. If the price is too low for some banks, making them technically insolvent, then at least the markets will know where they stand. The solution proposed is a time-honoured one for extreme workouts. There is no reason to believe it will fail.
As for Pearl Harbor, after the initial shock, America mobilised and some years later after a hugely traumatic and costly war eventually emerged victorious. Despite the apocalyptic commentary, particularly in relation to this plan, which with no particular line of reasoning is being widely condemned as doomed to fail, that looks like the way to bet this time too.
Centrica gains a place at EDF's nuclear table
After a reluctant and shambolic start, the Government seems to be getting it broadly right on nuclear renewal. There are obvious questions over the wisdom of selling our nuclear future to a state-controlled foreign enterprise, yet EDF also seems to offer the best chance there is of new nuclear build at little or no cost to the taxpayer.
For its £12.5bn, EDF gets all the company's residual income until decommissioning and its pick of the British Energy sites for new nuclear build. Four new nuclear reactors are planned, two at Sizewell and two at Hinckley.
At the same time, however, all of British Energy's other sites must be made available to rivals for new nuclear build, which ought to ensure a degree of competition in the nuclear sector. Many of these sites will be thought too far from the centres of population in the south to be viable, while the Scottish Executive's opposition to all things nuclear seems to make those north of the border off limits. All the same, there ought to be scope for at least four alternative reactors, and possibly more.
Centrica's involvement ensures an ongoing "British" interest in the industry as well as helping the French taxpayer to defray the risk. Even for a company of EDF's size, £12.5bn with another committed £12.5bn on top to pay for new nuclear build, is quite a bite. For choice, Centrica's Roger Carr and Sam Laidlaw would have preferred to buy the whole shebang, but this may always have been unrealistic. The company might have struggled to finance such a whopper.
All the same, it's a shame to be leaving Britain's nuclear future so beholden to foreign expertise and funding. There ought to be plenty of construction work for British interests in the programme of new nuclear build envisaged, but the design and the supply chain for the kit is as you might imagine almost exclusively French. Yesterday's deal is not just a commercial investment for EDF, it is also a job creation scheme for La France as a whole.
Still, assuming the memorandum of understanding holds good, Centrica emerges well from the transaction. For its quarter share of the asking price, Centrica gets not just 25 per cent of the equity but 25 per cent of the cash flow, 25 per cent of the power output of British Energy, and an option to invest in the planned new reactors.
The effect is to boost the amount of energy sourced from the company's own assets to meet demand from little more than 30 per cent to somewhere in the low 40s, putting Centrica well on the way to matching its main rivals, which tend to average more than 50 per cent. This ought to make charges and earnings less volatile, and thereby ensure the company attains a higher rating for its shares.
Why did EDF agree to bring Centrica to the party? Ministers insist it was nothing to do with them, but British Energy shareholders might well have played a role. Two of the biggest – Invesco and Prudential – are also big shareholders in Centrica. They'd frustrated an earlier, less generous, offer from EDF, and were quite capable of doing the same to this one too if the supposedly value-enhancing participation of Centrica hadn't been agreed to. Whatever. Centrica certainly helps EDF limit its risk, so it may in any case have been pushing at an open door.
Nicolas Sarkozy, the French President, would last night have been toasting an apparently triumphant piece of French industrial expansionism. Yet he might do well to reflect on the fact that the history of nuclear power in Britain is not a pretty one: it's eventually impoverished virtually every owner it's had to date.
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