- We need to cut up our credit cards now!
When I was in corporate banking, the definition of solvency that I used was ‘the ability to meet your debts as they fall due.’
This means that avoiding insolvency depends upon:
- the ability to meet all your expenses from current cashflow or
- that you have headroom within your current credit facilities or
- your financial standing is such that you have the ability to raise more credit to finance your deficit spending.
- having assets you can easily liquidate to repay the debt
In banking, we used to measure the solvency of our customers using solvency ratios – particularly those relating to liquidity, gearing and interest cover.
These immutable laws of solvency apply whether you are an individual, a business or a sovereign state.
The rules of finance dictate that the higher the risk of default, then the higher the cost of the credit.
This higher cost of credit increases the financing burden on the borrower which therefore increases the likelihood of default – in banking, we measure this risk using the gearing ratio – the amount of borrowing in relationship to the net worth of the individual, business or country.
Alternatively, interest costs as a percentage of net income, or the number of times interest costs are covered by net income, is also a good measure of risk.
Of course, the longer the borrowing entity loses money, or runs a budget deficit, the more the borrowings mount, the more the interest burden and the longer it will take to repay the debt.
In other words by borrowing to have more today, we effectively mortgage our future income and the less we will have tomorrow.
Unless interest rates are fixed on the borrowing for the term of repayment, there is the additional risk that interest rates will rise due to market forces beyond our control. The higher our gearing and the lower our interest cover, the greater the risk to our solvency.
These are the immutable laws of solvency.
The financially weak will often be exploited by the lender whilst they are powerless to negotiate, being dependant on the continuing support and goodwill of the lender. The lender does not want the borrower to default but will exact a high price for that support in times of crisis and uncertainty to cover the higher risk of default.
These are simple facts of life.
Let’s now turn to the finances of the UK under the stewardship of Gordon Brown and the Labour Party.
Some 13 0r 14 years ago, they inherited a sound economy following the austerity years of Maggie Thatcher and the Tory party. Since coming to power they have squandered vast sums of taxpayers money in implementing a huge social experiment during a time when we have seen many public sector budgets increase almost uncontrollably.
This has created the illusion of prosperity and asset bubbles have inflated, fueled by vast increases in the credit available from the Banks and foreign investors. Gordon Brown contributed to this bubble by changing the way in which the Banking system is regulated early in his Chancellorship – this meant that the banking regulators were ‘asleep at the wheel’ as the Banking system spiralled out of control.
As I was on the inside of the Banking system until 2001, I was a witness as the foundations of the current crisis were put in place and we were being incentivised to achieve targets that cried out against the very banking principles that had been drummed into us over the previous 20 years.
It was scarcely believable to me that we were being incentivised to abandon those principles of good banking practice that had been drummed into us and learned through countless years of banking experience. So concerned and disquieted was I by those times, the stress of the job became almost unbearable.
I just could not abandon those principles and values that were the foundation of everything I believed in as a banker.
I had no alternative but to resign voluntarily or risk the loss of my mental health – you cannot for long continue working at a job which you no longer believe in. To do so will impair your self-respect and integrity.
I therefore find it quite breath-taking that Gordon Brown seems to have absolutely no sense of integrity (or perhaps it’s just financial incompetance?):
- he has attempted to lay the blame of the UK banking crisis on a worldwide recession rather than his own incompetance
- he has master-minded a huge budget deficit in the UK and our solvency ratios are now so stretched that international regulatory bodies such as the IMF are sounding the alarm.
- to this government, ‘solvency’ is defined as the ability to print more money, thereby devaluing the debt and currency already in circulation.
- he has been at the head of a vast culture of government greed and over-spending where the public sector award themselves levels of pay and bonuses irrespective of the fact that they take no commercial risk and contribute almost nothing by way of wealth creation.
- the electorate have been cynically spoon-fed a diet of of spin and lies to hide the full scope of Labour ambitions to cling onto office
- we are now carrying a vast burden of people that are now totally dependant on state hand-outs for survival because the conditions for business are such that real jobs are not being created – on the contrary, they have been utterly destroyed. Creating more public sector jobs to fill the gap merely stors up more problems for the future.
He has clearly stated that he believes that it would be wrong to cut spending now as economic recovery starts to get traction
The problem is that, with the huge burden of debt that the UK and many countries are carrying around the world, any recovery is likely to be extremely weak and especially vulnerable to rises in interest rates.
In fact rises in interest rates are inevitable – they can hardly go lower than 0.5%!
Rates will have to rise soon, as the UK’s spending deficit cannot be addressed by a weak recovery and the markets will demand higher interest rates to fund our spending deficit. Every month that goes by, and we increase our debt burden, the more we will eventually have to repay and the higher the likely interest burden.
Through quantative easing, bank bailouts and various other schemes such as the scrappage scheme, we have merely delayed the evil day of reckoning. That suits Labour as they attempt to cling to power at the next election, but it is not in the interests of our UK citizens as a whole and certainly not for our children who will have the almighty task of working to repay our debt-mountain.
As we are now geared to the maximum extent as a country, we are now also particularly vulnerable to further financial shocks. And the potential for such shocks is everywhere – Greece, the US budget deficit and debt mountain, Iran, peak oil etc etc
I therefore believe from the bottom of my heart that we must have a change of Government – one that recognises that we must get out of debt as soon as we can, before the inevitable ‘expected unexpected’ happens. I don’t know what that will be – I just know it will happen and, as a country, we are not currently in a position to absorb much more pain.
Whoever succeeds Brown, will have no option but to lead us into an age of austerity because we have already mortgaged our future to the hilt.
The sooner we bite the bullet, face our debts and address them, then the better for all us. Britain has a solvency problem and, if the politicians do not recognise that fact, then the markets will force them to face it by refusing to fund the Government debts.
It will take integrity, extreme courage to do the unpopular and great leadership to do what needs to be done.
I’m not convinced that the person to do that has yet appeared at Westminster but we need to recognise that our Government has led us all inexorably down a path of insolvency and we now need leadership that fully understands the immutable laws of solvency.
As individuals and business owners, we also need to adhere to these laws or face the inevitable consequences of breaking those laws. And the longer we take to square up to our responsibilities and these immutable laws, the harder it is to recover.
P.S. If you think Northern Rock, Bank of Scotland and Royal Bank of Scotland were just unlucky victims of the credit crunch, think again. They were the most aggressive competitors when I was in Banking, always willing to take greater risks at lower prices. They deserved to go bust – what they didn’t deserve was to be bailed out by the tax-payer. The payment of bankers bonuses in such circumstances just illustrates again their shocking lack of integrity.
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