"We are so, so very sorry and please do feel free to punish us, preferably with a good thrashing, as much as you like." OK, so that's a slightly exaggerated version of the Lloyds TSB response yesterday to news that it was being fined £1.9m for the mis-selling of extra income growth plans, but not much of one. As self flagellation goes, the Lloyds TSB press release was something of a master piece. By cooperating fully with the Financial Services Authority and then agreeing to yesterday's very public flogging, Lloyds TSB has headed off the possibility of even worse punishment to come. In that regard, there is something to be said for the grovelling apology.
Yet is Lloyds TSB entirely wise to be so contrite? Savers lost money. So what. That's what happens with equity-based products. If investors are able successfully to sue for compensation everytime they suffer a loss, eventually no one will bother to sell them anything at all. Instead savers will get base rate whether they want it or not.
Not for nothing are such saving plans sometimes known as "guaranteed bonds". The literature scarcely justifies the description, but the FSA's growing willingness to order compensation when things go wrong might indeed lead you to that conclusion.
That said, there is little excuse for the way Scottish Widows, the responsible Lloyds TSB subsidiary, behaved in concocting and marketing these ridiculous products. The genesis of the mis-selling lay with the fact that precipice bonds, as they are also known, are extremely costly to produce. In order to work, they have to be expensively hedged in derivative markets. To make the hedging cost effective, they therefore have to be produced in relatively large batches, which must then be sold come what may if they are to wash their face. Sell only half of what was anticipated, and the batch becomes seriously loss making.
That's what created the pressure for overly aggressive selling. The other pressure was the determination at Lloyds TSB to make the £5.5bn acquisition of Scottish Widows show results. The prime justification for the deal was that Scottish Widows would be able to sell a lot more of what it produced once given unfettered access to the Lloyds TSB branch network. As a result, the extra income growth plans were inappropriately sold, often to the elderly and often to people with no previous experience of equity-linked products. They were literally shoved down people's throats by unscrupulous, uncontrolled and untrained salesmen.
In point of fact, most of these bonds are essentially a con. In investment, there is no such thing as a free lunch. The higher the interest rate, or promised rate of return, the higher the investment risk. Derivative markets allow investors to trade that risk. Put simply, the reason the offending extra income growth plan was able to pay such a high rate of interest is that someone was paying the plan a lot of money to shoulder the risk of their equity portfolio showing a substantial fall. The buyer of the product took on the risk instead. In wholesale markets, the principle is well understood, but retail savers tend to be less familiar with it.
With nearly all structured bonds, investors would be better off simply sticking their money directly in the stock market. The cost of the hedging is not worth the candle and, in any case, investors expose themselves to catastrophic loss should stock markets behave abnormally, as they sometimes do.
The FSA says there was nothing wrong with the product, only with the way it was sold. I disagree. There was everything wrong with the product but I would defend to the last the provider's right to sell it. Read into the literature that accompanies these plans, and the risks are invariably well spelt out. It is hard to summon up much sympathy for the "victims" of this mis-selling scandal. They fell prey to their own greed and carelessness in thinking it was possible to have a risk free return of 10.25 per cent a year. Thanks to the FSA, they haven't had to suffer the consequences. Is that really such a great outcome?
According to an article in the Bank of England "Quarterly Bulletin", published today, corporate debt is at record levels relative to the market value of the capital which must ultimately service that debt. The same is true of secured household debt. Mortgage debt per household is now higher relative to income and wealth than it has ever been before, confirming the impression that Britain has become a nation of debters.
Should we be worried about this? On both counts the Bank seems relatively relaxed. With high levels of corporate debt, there is plainly a risk that any further shocks to the economy might cause many companies to have difficulties servicing their loans. The other risk is that pressure for debt repayment might lead to further sharp cutbacks in corporate spending, compounding the already deep recession in business investment.
In point of fact, say the article's writers Philip Bunn and Garry Young, the required balance sheet adjustment is much more likely to be gradual, with companies repaying debt from retained profit or from equity issues than cut-backs in capital spending. I hope they are right, for heavy levels of indebtedness after the investment boom of the late 1990s was one of the biggest causes of the subsequent business downturn. If even after three years of vicious cutbacks, corporate debt is still at record levels, it seems to me inevitable that companies will be watching the pennies for some time to come. It's hard to reconcile continued high levels of corporate indebtedness with a strong cyclical rebound in business investment.
One of the big unanswered questions for economic policy makers is whether persistent economic sluggishness is down to the geo-political shocks of the last two years - from 11 September to Iraq - or whether the excesses of the bubble and the financial imbalances built up at that time are still the main explanation. That question is most starkly posed in the US, where the excesses of the late 1990s were much greater than in Britain, but with corporate indebtedness still so high, it is plainly relevant here too.
In any case, high levels of both corporate and household debt are self evidently going to continue acting as a break on the economy for some years to come. The Bank is probably right in believing that in a low inflation environment both the household and corporate sectors are capable of living with higher levels of debt than they have tolerated in the past. Indeed, it expects secured household debt to continue rising relative to income for at least the next five to 10 years, if only because the high cost of housing dictates that more debt household is acquired every time a property changes hands.
The Bank is right to think these trends shouldn't cause undue alarm. They don't have to end in tears. Yet they may significantly damage the UK's ability to grow strongly. Common sense dictates that the spending tap must be switched off once debt gets too high.
The Government is wasting the Competition Commission's time in referring Littlewood's £570m acquisition of Great Universal Stores' mail order business. The world has moved on since the predominant form of home shopping and small time credit was agency mail order. Today, credit is easy, even for the socially disadvantaged, and mail order is just part of the wider retail market. The implied threat that the GUS business will be closed if the Competition Commission forces the Barclays to divest it should be taken with a pinch of salt. Buyers won't exactly be beating a path to their door, but no doubt someone would be willing to pick it up for a knock-down price. Even so, this is a business in steep decline and the Barclays offer some hope of revitalisation. Agency mail order is not a discreet part of the market any longer and, as a percentage of the whole, the combined market share is not excessive.Reuse content