The secret case for privatisation

Ross Gittins had a piece in the SMH yesterday offering an intriguing line of defence for the privatisation proposals of the Iemma government, in the face of attacks from me and Nicholas Gruen. As Gittins concedes Iemma’s arguments, based on the idea that the sale will protect the states AAA rating and allow for new investment in infrastructure, don’t stand up to scrutiny.

He starts off promisingly enough

You don’t have to be very bright to pick holes in the arguments Morris Iemma and Michael Costa have been using to sell their plan to privatise electricity.

But it seems you have to be wiser than some of our brightest economists to comprehend the deeper issues involved … Various economists, including Professor John Quiggin of Queensland University and Dr Nicholas Gruen of Lateral Economics, lost no time in blowing these arguments out of the water. But it doesn’t seem to have occurred to my learned friends that they’ve been busy demolishing a straw man. They may be economic geniuses, but they have more to learn about the politics of economics.

The line implied here and spelt out later on is that, while the ostensible case for privatisation is nonsense, there are deeper reasons which Iemma can’t acknowledge, but which provide a compelling case. It sounds promising. Unfortunately, Gittins makes rather a rhetorical mess of things.

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White knights

It’s just been announced that JP Morgan will buy Bear Stearns for $2 a share, implying a value of about $250 million. Given that the company headquarters is said to be worth about $1.2 billion, that gives the BS banking business a value of negative $1 billion. And that’s only after the Fed agreed to take on $30 billion worth of toxic waste from the BS portfolio, politely described as “less-liquid assets.â€?

Clearly, under any normal circumstances, a company like this would have been left to go bankrupt. The problem is that this would jam up the entire credit market because BS is a counterparty in a vast range of transactions with other banks. (We debated this issue a month ago here and at CT with a number of commentators arguing that the problem of counterparty risk was not such a big deal).

Some light relief is provided by the announcement by Standard & Poors, the day before Bear imploded, that the worst was over. This will go down with Irving Fisher’s comment in late 1929, that the stock market had reached “what looks like a permanently high plateau”. But at least Fisher wasn’t being paid to judge the stock market. Surely it’s now time to kill off the quasi-official role of the ratings agencies, as Justin Fox has just argued in Time

Looking ahead, the limits of the white knight strategy employed in this case must be approaching. JPM will take a while digesting this mess, and Bank of America has already done its bit when it agreed to rescue Countrywide. The other big banks have their own problems. Any future maidens in distress will have to look directly to Uncle Sam for a rescue.

Update Readers used to the natural order of things might be concerned by the implication that with such a giveaway price, the top brass at BS might be forced to bear the financial consequences of events that were obviously beyond their control. Never fear. According to this Reuters report in the Guardian, while most employees up to junior executive levels will lose both their jobs and the shares they were encouraged to buy, with no “golden parachutes”:

JPMorgan Chief Financial Officer Mike Cavanagh late Sunday said taking over Bear would generate about $6 billion in merger-related costs.
JPMorgan has not broken down those figures, but much of that will be earmarked for severance pay and potential exit packages for top executives like Schwartz.
A person familiar with the transaction told Reuters that roughly $1 billion of those costs would be earmarked for severance and retention.

The Liberal brand

The Liberal party finally has something to celebrate, with their most senior elected official, Brisbane Lord Mayor Campbell Newman winning re-election easily and the Liberals getting a majority on the City Council for the first time in many years. But despite this story in the Oz, the news is not all good for the Liberal brand.

* Newman’s success was largely a reflection of his personal popularity. A good point for the Libs is that this popularity is largely due to his promise to fix traffic congestion through road and tunnel projects, an issue the Liberals probably have an advantage on in general. A less good point is that it remains to be seen if the plans will work – this approach hasn’t been hugely successful elsewhere

* In Townsville, Labor copped a hiding but the conservative candidate Les Tyrell didn’t run under the Liberal label

* In the Gold Coast mayoral election, the Liberal Party spent a fortune but their candidate finished third with 26 per cent of the vote. There’s an outside chance that he could get up thanks to the vagaries of preferences but it looks pretty unlikely. Joe Hockey calls this a “great result” but if so, I’d hate to see a bad one.

All of this is relevant to the issue of whether the Liberals and Nationals should merge under a new name. I suggested the day after the election that this was inevitable, and copped some flak for it, but the idea of a merger is certainly alive now.

The remaining objection to a merger with a new name is that it would lose the value attached to the Liberal “brand”. My reading of the council election results is that this value is either zero or negative. Popular conservative candidates can win without the Liberal name. On the other hand, even in natural Liberal territory like the Gold Coast, the party label alone can barely attract a quarter of the votes even with a big advertising push.

Given general agreement that the obvious choices of NatLib and LibNat are uninspiring at best, I’ll throw it open to readers to suggest a new name for the merged party. The winning entry as judged by me will be announced in a later post.

The one-hoss shay

The Fed’s bailout of Wall Street investment bank Bear Stearns has, unsurprisingly, been discussed in terms of the domino theory. A more appropriate metaphor is The Wonderful One-Hoss Shay . This was a carriage constructed on the theory that a system always fails at its weakest spot.

he way t’ fix it, uz I maintain, Is only jest T’ make that place uz strong uz the rest”.

On the Fed’s current approach, the system is unbreakable, provided that “too big to fail” protection is extended to every significant firm in the system. The result of this protection is that the kind of crisis where the failure of one firm leads to a cascade of failures elsewhere is prevented. But then

First a shiver, and then a thrill, Then something decidedly like a spill,– And the parson was sitting upon a rock, At half-past nine by the meet’n’-house clock,– Just the hour of the Earthquake shock!

–What do you think the parson found, When he got up and stared around? The poor old chaise in a heap or mound, As if it had been to the mill and ground! You see, of course, if you ‘re not a dunce, How it went to pieces all at once,– All at once, and nothing first,– Just as bubbles do when they burst.