Jeremy Warner's Outlook: Greenspan begins road back to higher rates

Private equity bids; Sainsbury's return?
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The Independent Online

Across the world, central bankers are gently applying the brakes, overtly in Britain and Australia, where short-term rates are already off the bottom, but still with the foot poised for action just above the pedal in the US and Japan. Even in sluggish old Europe, the chances of another rate cut before the cost of money starts to rise again have receded sharply in recent weeks.

Across the world, central bankers are gently applying the brakes, overtly in Britain and Australia, where short-term rates are already off the bottom, but still with the foot poised for action just above the pedal in the US and Japan. Even in sluggish old Europe, the chances of another rate cut before the cost of money starts to rise again have receded sharply in recent weeks.

What everyone is desperate to avoid is frightening the markets with too rapid or unexpected a tightening, thereby bringing the recovery to a grinding halt. Inflationary pressures are beginning to build all over the place, yet with both public and private debt at or near record levels, too violent an application of the brakes would very likely produce a nasty road crash.

Thus in the US last night, Alan Greenspan, chairman of the Federal Reserve, reiterated that higher rates are coming, but not yet. However, the language of the Federal Reserve's Open Markets Committee is subtly changed. Gone is its pledge to be patient with policy. In its place is a commitment to remove the present accommodative stance at a "measured" pace.

Here in Britain, we've already had two quarter point rises, but with three months between them. The Monetary Policy Committee has encouraged us to believe that this will be the pattern, with the next one due this week, the one after in August, and so on and so forth until rates are brought back to a more normalised level of around the 5 per cent mark.

The big question is whether they've all left it too late for "measured" behaviour. Personally, I think the answer is almost certainly so in the United States, but it's not such an open and shut case for the UK. The big unknown is the housing and domestic credit markets, which have worked wonders in sustaining Britain through the world-wide recession, but now pose a quite significant threat to our continued economic wellbeing.

If interest rates go too high, they might provoke a housing market crash, thereby damaging demand and sending the economy into a tailspin. The majority view of the Monetary Policy Committee is that interest rates are not the right policy tool to address the house price bubble. Rates can be used to deal with the effects of the bubble on inflation and demand, but not the bubble itself. This is a convenient way of ducking the issue. We will have to await next week's Inflation Report for a fully explanation of the Bank of England's logic.

Private equity bids

Graham Kirkham, chairman of DFS Furniture, has probably bid enough to to assure success with his latest 442p a share offer. The fact that the shares continue to trade marginally higher than the terms of his bid is more down to Lord Kirkham's additional agreement to pass on the proceeds of ongoing Primback litigation, potentially worth an extra £60m, than the expectation of higher, rival offers. The bid is still subject to satisfactory due diligence, but you would think the chairman knows as much as there is to know about the company, so the outcome looks already conclusive.

None the less, shareholders will be selling themselves short by accepting Lord Kirkham's bid. Regular readers of this column will know of my objections to private equity bids for publicly quoted companies. If some clever financier or manager thinks it is worth bidding such and such a price for a listed company, then it is almost certainly worth an awful lot more. The alchemy is achieved by paying for the cost of the equity with debt. Substantial fees will be extracted along the way for arranging the debt, be it through conventional bank finance or through bonds. The company is then run for cash until the debt is paid off, at which point the remaining value of the company is in for free.

The process doesn't always work as it's supposed to, but it works often enough to make private equity as a whole extraordinarily lucrative for nearly all involved. The ultimate losers are traditional buy to hold investors - pension funds, life companies and the like. Seduced by the prospect of short-term performance gain, their outside fund managers will in many cases be selling out at below average buying prices. Worse, these are the very same investors who will be prevailed upon to buy the companies back once the financiers have sucked the lifeblood out of them and they are judged ready to be refloated on the stock market.

Small wonder that long-term holders of publicly listed stocks are beginning to call the people who manage their money to account. It's as if they are having their pockets felt.

Lord Kirkham says his company faces difficult times ahead, and these are much better dealt with privately than in the publicly quoted arena. A similar argument is being used to justify Permira's mooted private equity bid for WH Smith, where it is claimed that the high level of leverage customary in private equity makes it unacceptably risky for traditional stock market investors.

Poppycock. Managements and investors need to be more robust in defence of their assets. Private equity is just a way of transferring wealth from the many - pension funds and other forms of mass, long-term investment - to the few. Just occasionally, listed company investors will get the better end of the deal, which will go spectacularly wrong for the private equity bidder. Yet it doesn't happen often enough for ordinary investors to be confident that private equity bids offer a reasonable trade in risk.

Sainsbury's return?

It's one of those stories which is impossible to verify without confirmation from the horse's mouth itself, but I did laugh at the suggestion that Lord Sainsbury of Turville is planning to quit the Government to come to the rescue of the beleaguered supermarket group that bears his name.

The Labour peer was a disaster as chairman of J Sainsbury. The mistakes made while he was at the helm are the main reason the company is now in such poor shape. When he started as chairman and chief executive, Sainsbury still had market leadership. When he left, the company trailed Tesco by some distance, and today it is just an also ran number four in the supermarkets league table.

Lord Sainsbury's recent admission on Desert Island Discs that he never goes shopping except to buy bread at a nearby French boulangerie, helps to explain why. Retailers that have learned their trade from management textbooks are bound fail. Sir Peter Davis, the current chairman, has likened the Sainsbury's he inherited from David Sainsbury to a run-down old boarding house. To put him in any kind of a position of influence at Sainsbury's would be a bit like inviting Lord Simpson back to turnaround Marconi.

The truth of the matter is that Lord Sainsbury is much better at being minister for science and innovation, a position he has used to some effect to improve the affairs of the nation, than he ever was as a chairman of Sainsbury. He also admits to being personally much happier in his present role than the one he was born to, which always weighed heavily on his shoulders. For the record, the Department of Trade and Industry says he has no plans to go.

Yet no one is suggesting that Lord Sainsbury would return in an operational role. The Labour peer's Government position means that his 23 per cent holding in Sainsbury must be placed in a blind trust over which he has no control. If he wants to take charge of his inheritance again, he must leave the Government.

It has long been my view that the blind trust arrangement is highly damaging to Sainsbury. The company is not properly accountable to the City because it is controlled by the Sainsbury dynasty, but with the lion's share of the controlling family stake tied up in a blind trust managed by a polite but non-interventionist lawyer called Judith Portrait, nor is it properly accountable to its leading investor. All organisations where there is no accountability are condemned to drift and decline.

Laughable though the idea of David Sainsbury returning to the family seat would seem, it might actually do some good if the landlord takes an interest in his estate once more.