Outlook: Confusion reigns as the Fed's Greenspan turns positive

BA/Iberia; Standard Life
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The Independent Online

One minute the US Federal Reserve is warning about the threat of deflation and considering the use of "unconventional measures" to combat it, the next it is looking forward to a robust second-half recovery and dismissing "situations requiring special policy action" as "most unlikely to arise". Has Alan Greenspan, the chairman, utterly lost the plot? Even after the disaster of the unchecked bubble, it is not thought of as proper in respectable circles to criticise the great magician, but in recent months he's sent out such a bewildering array of conflicting messages that maybe it really is about time he was shunted off into retirement.

OK, OK, so yesterday's bi-annual testimony by Mr Greenspan to the US Senate Committee on Banking, was the usual, heavily qualified, calibrated affair. He did not say outright that the US economy was about to boom again, nor even that recovery was assured. He also continued to warn about the remote possibility of deflation, and perhaps more significantly about the risks of the growing budget deficit.

However, on balance this was one of the most upbeat assessments he's given in a long time and therefore quite difficult to reconcile with recent, unambiguous warnings about the possibility of deflation. Economic conditions can change very rapidly, and to be fair on Mr Greenspan, there are a lot more reasons to be positive now than there were even a few weeks ago.

Nor can a central banker who has said it is not his function to pre-empt bubbles, only to deal with their consequences, be expected to admit that remedial policy is failing. The Fed stands ready to do everything necessary to achieve a return to satisfactory economic growth, he insisted in yesterday's testimony, as if to say that the Fed really is infallible and come what may, will eventually magic up the looked for recovery.

The trouble with magic is that it only works if everyone believes in it. Any obvious fault in the illusion and the game is up. By warning of deflation, Mr Greenspan caused an almost extraordinary further drop in already exceptionally low bond yields. Yet there was no follow through in the form of unconventional measures or the half point cut in interest rates the markets had been led to expect.

As a consequence bond yields have returned to former levels, removing a lot of the monetary easing that had been achieved. Now Mr Greenspan is actively talking up "prospects for a resumption of strong economic growth", further undermining the reduction in long term interest rates that is perhaps a necessary backdrop to any such rebound in business investment. Confused? Not half as much as the markets, or one half suspects, the grand illusionist himself.


Good morning and welcome to la linea aerea preferida del mundo. True, it doesn't have quite the same ring in Spanish but the World's Favourite Airline would like everyone to know that it is keen on a marriage with Iberia. The Spanish senorita would like to tie the knot with British Airways too and has been lifting its skirt recently to show off some rather enticing operating margins.

In theory there is nothing to prevent BA merging with Iberia - a deal which would effectively result in a takeover of the Spanish flag carrier as BA is almost twice the size in most respects, including market capitalisation. There would also be a lot to commend such a union in practice. Iberia, which was privatised in 2001, runs on the same philosophy as BA and is a near perfect fit in geographic terms. The Spanish are big in Latin America whereas BA has a strong presence in the Middle and Far East. They also have an existing relationship within the oneworld alliance, which is held together by the cement of BA's 10 per cent shareholding in Iberia.

Yet there are obstacles aplenty, not least in the arcane and outdated nationality and ownership rules which still govern airlines. These are what have twice scuppered BA's attempt to merge with KLM. There is nothing to stop BA buying a majority of Iberia's shares, but once it did so Iberia would no longer be a Spanish airline and would therefore forfeit its landing rights in every third country outside Spain and Britain.

Reforms being championed by the Commission's (Spanish) Transport Commissioner, Loyola de Palacio, would eventually have the effect of turning BA and Iberia into European Union airlines, allowing the Brussels rather than member governments to negotiate changes to the nationality clauses in air service agreements. Past experience of the snail's pace of open skies talks suggests is may be a long process, but BA's Rod Eddington can only hope. Hasta la vista, as they may one day be saying at BA's Waterside headquarters.

Standard Life

Last time carpet-baggers attempted to force Standard Life, Europe's largest mutually owned life assurer, to demutualise, the board saw them off, but only just. Three years later and they are back, this time led by a former college lecturer, David Stonebanks, who yesterday strolled into the life company's Edinburgh head office with his wheelybag full of 2,000 signatuaries and emptied it on the floor. The board plans to spend the next two weeks checking the authenticity of every single one of them, such is the ferocity of its opposition to conversion.

Even so, another demutualisation vote now looks inevitable. What's more, the board may find it even tougher to resist this time around than when Fred Woollard, a Monaco based fund manager, made his bid for demutualisation three years ago.

The board has since surrendered much of the moral high ground in preaching the supposed benefits of mutual ownership by awarding itself substantial bonuses at a time when it has been cutting back on payouts to policy holders, and although historically Standard Life policies have tended to do better than peers, there are growing doubts about whether such outperformance can be sustained, or even whether there is such a thing as a mutual dividend at all.

Standard Life has famously maintained a much higher exposure to equities throughout the bear market of the last three years than any other life assurer, and as a result its capital reserves have been cut to bits. According to some analysts, Standard Life policyholders face years of poor bonus payments as the company attempts to rebuild reserves.

The flip side of that particular story is that the company would also be worth a lot less on conversion than it was. Last time around, policyholders could reasonably have hoped for average windfalls of around £6,000, similar to those paid to policyholders of Scottish Widows when the company was taken over by Lloyds TSB. Today they'd be lucky to see £1,000, such has been the destruction of capital since then.

The deterioration in Standard Life's financial affairs points to a flaw in the capital structure of all mutually owned life assurers. When they have large and healthy reserves, as was the case with Standard Life a few years back, they become targets for carpet-baggers, keen to cream off the surplus. But ifthey run minimum reserves, by overpaying policyholders and pouring resources into expansion, they risk running out of money altogether, as occurred with catastrophic consequences at Equitable Life.

Standard Life's finances are nowhere near as bad as that, but the misjudged bet on equities has forced the society to fall back on "future profits" to meet solvency requirements, and if there were to be a conversion tomorrow, it is not clear there would be much appetite for such a thinly capitalised company. The mouth watering reserves of yesteryear have gone, eaten up not just by the bear market, but also by overly aggressive expansion, both at home and overseas.

Mr Stonebanks stands a better chance than his predecessor of success, such is the scale of general disillusionment with those who run our savings institutions, whether mutually owned or not, but the spoils are likely to prove a great deal worse.