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The financial system is clearly taking a battering, but one wonders if the real casualties, when the dust settles, might not be the politicians as much as the bankers.
This is because in times of stress people look to their politicians to do something to limit the damage and provide leadership. But what the events of the past few days have demonstrated is that the scale of the problems are so great, government is virtually powerless to deal with them. The global financial system now operates on a scale that dwarfs the resources of nation states.
This was evident from the early days of the crisis when the Swiss bank UBS got into difficulties and admitted it had potential exposures of Swfr2 trillion (£1.3 trillion) . The entire Swiss GDP at the time was under Swfr500 billion — so the bank's potential problem was four times the size of the entire country.
Similarly, the American bailout of mortgage lenders Fannie Mae and Freddie Mac two weeks ago stretched even the mighty US finances to the limit. After that deal the markets started making a price on the possibility of default by the US government. The chance was minuscule but the fact it is there at all is a sign that enough was enough.
In truth, the signs have been around a lot longer. One just has to go back to 1992 and our ejection from the ERM. When the Bank of England stepped into the market to take on the speculators it was overwhelmed. Had it persisted in that hopeless fight, the nation's entire reserves accumulated over centuries would have lasted about 20 minutes. Not for nothing did Bill Clinton, then the US President, say in his next life he wanted to come back as the bond market “because it scares everybody”. He knew that finance was where the real power lay.
This may raise the question of what politicians are for, but they do still have a role to play. The clue lies with the Bank of England. Once a month we go through the ritual of the monetary policy committee setting interest rates and that is the signal for a huge amount of speculation in advance about whether there will be a cut.
But the fact is that in economic terms a cut of one quarter of one percentage point, or indeed a similar-sized increase, makes not a blind bit of difference to the perforance of UK Plc in the near term and will take months to have even a minimal impact. What a change does do, however, is affect the mood. It is not the act but the activity which makes the difference. So in effect we live in an age where central banking is theatre — it makes an impact through our emotions or not at all.
Calling XL to account
There is a risk in all this market turmoil that the collapse last week of holiday company XL will not get the attention it deserves. If ever there was a business that was an accident waiting to happen, this was it.
The following example makes the point. The business went public on the Icelandic Stock Exchange in January 2006, and the accounts on which the flotation was based were for the period up to October 2005.
Holiday companies always do much better in the summer months, so one can see why that was the chosen accounting period. However, there was a further twist — inflight catering was supplied to XL by a company called Alpha Airports. Just before the float, XL approached Alpha and asked if it would agree to spread the cost of catering more evenly throughout the year, notwithstanding the fact the bulk of the food was used and the cost incurred in the summer months when the planes were full rather than half-empty.
Alpha took legal advice and agreed, if only because it did not want to upset a major customer. It messed up Alpha's cash flow a bit, but the effect in terms of XL's business was to take cost out of the summer season and transfer it to the winter one. The effect on the accounts was to boost the summer profit and depress the winter one — so the pre-flotation profit figures got the benefit. The float was a success.
Some months later, Alpha's auditors PricewaterhouseCoopers discovered the arrangement, and decided it was not on. They then went to KPMG, auditors to XL, and made their concerns known. KPMG resigned from XL shortly afterwards, though whether this was cause and effect is not clear — they may have quit for some other reason entirely.
Auditors resigning from an Icelandic-listed company is not a high-profile event, and the company continued on its merry way until last week, some two years later, when it went bust.
It is unlikely this was as big a surprise to all those advisers who collected fees for bringing the company to market as it was for the little people who found themselves stranded or deprived of their holidays.
