Gestaltz

A slight change in focus can produce a profoundly different understanding https://twitter.com/gestaltz

Calculating the Return on Property

Investing in property most usually involves leverage (see the previous blog; Rent or Buy). A deposit of equity is combined with a mortgage to meet the cost of purchase. Total return (net yield plus capital gain) is normally expressed as a percentage of the deposit of equity. The effect of leverage is to magnify returns calculated in this way and make property look a compelling investment. Combine this with the popular myth that property prices always rise and you can see why everyone wants to own property. Buying a mortgaged property is one of the few opportunities for leverage that individuals have in modern economies. But this does not mean it is always a good idea. In part it is the method of return calculation that has created this institutionalised phenomenon.

Calculating return as described above makes some sense if the deposit of equity is the purchasers only risk. The distribution of returns is bounded by -100% on the downside and converges asymptotically towards infinity on the upside. But the deposit of equity is not the only risk. If all goes wrong the mortgagee cannot simply hand the keys back and walk away from the mortgage debt. The mortgagee can sell the property and use the proceeds to pay back the debt but if the proceeds are insufficient then the mortgagee remains liable for the difference, which may exceed the initial deposit of equity. Buying a mortgaged property (or any leveraged investment) requires Economic Capital and the individual mortgagee is typically undercapitalised. This exaggerates the calculated return when things go well.

Economic capital converts the risk of an investment into the capital sum required to realistically support it. I first came across an attempt to operationalise this idea at Bankers Trust (1986) in the form of a risk adjusted rate of return on capital (RAROC). I shared an office with the man running the programme. BT was made up of a large number of trading desks. In order to assess the relative performance of each desk an estimate of the economic capital used by each desk was calculated using the RAROC equation and the return of each desk expressed as a % of economic capital. Just making a lot of money was not enough. It had to be done using as little economic capital as possible.

The applicability to calculating property returns and comparing with, say, un-leveraged equity returns should obvious. The economic capital at risk with an un-leveraged equity investment is the same as the actual capital invested. The most you can lose is your investment. The economic capital at risk with a leveraged property investment may well exceed the deposit of equity. Deposits of capital are typically 10% and property prices can quite easily fall by more than 10%. The economic capital that individuals commit to (but do not fund) when purchasing property typically exceeds the deposit and it is the economic capital figure that should theoretically be used when calculating return. The effect would be to lower rates of return.

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Rent or Buy

The issue of whether it is best to rent a home or buy a freehold property comes up again and again. It is usually dealt with in numerical terms with plenty of heroic assumptions obscuring the important points. I have written such blogs myself. My opening sentence already conveys more qualitative information than many such discussions. You rent a home. You buy a property, which can be a home but is also an asset. This blog tries to clarify some important issues that need to be considered when making this decision.Some are obvious, others less so.

Buying a freehold property is best for those that wish to put down roots in a specific location. The costs of buying and moving are very high. You need to get it right and only have one shot at it. Property can be illiquid so a forced sale can be at a poor price. If circumstances change it can add to the stress and cost of the change. Buying property is a commitment and suitable only for those that are able to commit. Renting is more fluid and flexible. It suits those that are not yet certain where they wish to live and has relatively low costs of moving. The main drawback is availability of suitable properties and the lack of security in the tenancy. This latter point is often misleading. Landlords need tenants so good tenants paying the market rent are probably as secure as homeowners. Moreover, tenancy agreements can be negotiated.

Owning a freehold property confers more independence and responsibility. You are responsible for maintenance, insurance, etc. You have the option of DIY maintenance. Owning a leasehold involves a freeholder and loss of control of maintenance and buildings insurance. Moreover there may be a lack of transparency with little maintenance and unexpected bills, despite a regular service charge (check the sinking fund). There is also the stress and expense of extending the lease. Buying a leasehold without a simultaneous share of the freehold is a dangerous enterprise. Careful note of the ground rent and escalation is advised, especially on new builds. Renting forces you into a continuous relationship with the letting agent and/or landlord. However, if the letting agreement is sensible this relationship should be transparent and predictable. The key to renting is the letting agreement and if this is negotiated carefully later problems are avoided. Once again, landlords need tenants and good tenants have security and peace.

Renting is often viewed as a waste of money leaving you with nothing to show for your time. This is a false view. You are paying for housing services. Buying a property, freehold or leasehold, for owner occupation also involves paying for housing services. The difference is that you simultaneously make an investment in the property in which you live. Most people’s net worth is tied up in the property in which they live, which from an investment perspective is a bad idea. There is no diversification in your portfolio. If you also work locally this could become catastrophic if you lose your job. Owning a property in the area in which there is a single dominant employer is particularly daft. If the employer fails you may have no job and be unable to sell the property. This is why so called ‘depressed towns’ have emerged. Renters can up sticks and move.

The ‘renting is a waste of money’ view is largely based on two heroic assumptions. First property prices always rise. This is not true and in particular areas they may go down even when the overall property market is booming. Second, the only amount at risk is the deposit in the property (Economic Capital is covered in the next blog). Small steady increases in property prices can make attractive returns because property ownership normally involves leverage. If you put down a 10 % deposit on a 500k property and the price rises by 3% then your return on capital, as typically calculated, is 30%. Not bad. However, it is important to keep in mind you are always on the hook for the loan. If all goes wrong you cannot just hand the keys back to the bank and accept the loss of the deposit. Equity can become negative and the house is the asset which you can dispose to clear the debt but it may not provide sufficient funds to do so. Your capital-at-risk is much more than the deposit. So calculating returns as a percentage of the deposit may exaggerate the return.

The cost of housing services is not materially different whether you rent or buy. The difference is that you can recoup some of your costs through a leveraged, albeit un-diversified, investment in the property with some nice tax advantages. The (implicit) rent you pay yourself incurs no tax and the capital gain is tax free. The implicit rent merely covers the mortgage interest, maintenance, and insurance which is included in any rental agreement, so, apart from the potential income tax advantage, is a wash. The real investment kicker is the leveraged capital gain, helpfully free of CGT. The heroic assumption is that a capital gain is always forthcoming, which need not be the case. This is especially true if you buy a leasehold and fail to extend the lease. Moreover lease extension involves more outlay.

It should be fairly clear by now that what home ownership offers in financial terms over renting is the possibility of leveraged capital gain. Given recent history this might seem compelling but it is not without risk. The problem is that it is hard for the person-in-the-street to obtain this kind of leverage in any other way. A bank will give you a mortgage on a specific property several times the deposit and your annual income at a reasonable interest rate but it will not do so for, say, a portfolio of equities. This portfolio might consist of banks, REITs, and house builders. The reason is that whilst the home owner is un-diversified the bank has millions of mortgages spread across the country. The bank is well diversified and is in control of the diversification. Ironically the equity portfolio may be even better diversified but the bank will not extend an equivalent loan. One reason is that an equity portfolio is marked-to-market (valued everyday) but the mortgage portfolio is not. There is an illusion of stability.

If one removes the leverage facility from the equation property returns look less spectacular and equity returns start to impress. It is possible to use your deposit to invest in equities through a tax advantaged wrapper and use the returns to offset the cost of renting. Of course the absolute return will not match the potential of home ownership because of the lack of leverage. If one can persuade a bank to lend for the purpose of investing in a portfolio of equities on the same terms one would see that the choice of rent or buy is best made on the basis of lifestyle and personal needs for services rather than because it is potentially a way to increase net worth. The institutional bias towards leverage for property ownership is distorting the housing market. For many mobile, young people, renting is a sensible choice.

Relationships and the Kanye West Factor

Kanye West intruded into my consciousness about a year ago. I was having a pleasant lunch with an old friend when Mr West was introduced into the conversation, which was on politics. The opinion of Mr West on anything had never interested me, anymore than any other rapper, TOWIE star, Kardashian, etc etc etc. I felt disappointed. In what reality did my friend live thinking I would be interested in the political opinion of Kanye West, I wondered. Clearly, she did not know me as well as I had come to assume. Kanye West proved to be a seminal point in my existence.

The incident provoked some deep introspection and self-assessment. It helped that I had just turned 65 and it was a good time to review. The conclusion was that it was time to reset. Relationships are formed over time and often become anchored in a specific part of the formation, much like memories. Should you continue with relationships where the other party sees you as you were rather than as you are (or wish to be)? Now I was never a Kanye West fan so clearly this old friend had never really grasped who I was but the jolt was helpful in provoking a reset.

Reset may not be possible with all associations. This is especially true of siblings where the relationship has existed since birth and the linkages are tight. The sense of loyalty and affection can be overwhelming. However, even sibling relationships can be partially reset if the relationship has discontinuities. Long standing continuous relationships are also difficult to reset and usually need no reset because the association has been accompanied by a continuous update. The key is discontinuity. It is in these phases that we move in different directions. We become someone else and they become someone else but we try to relate as we were. I have been on an orthogonal path to all those that take an interest in Kanye West, TOWIE, MIC, Kardashians and all such cultural phenomenon. If you have an interest Derrida, Foucault or Barthes, there may some hope for connection.

Reset is a simple exercise. One poses the question. if I had just met this person would I wish to continue the relationship? It is a difficult exercise because one needs to detach from the history. There may also be a fear of detachment and finding oneself alone. We spend our lives forming useful as much as enjoyable associations and it is a hard habit to break. It is nevertheless important to be clear (in ones own mind) why we continue the relationship. It will help calibrate expectations and avoid disappointment. One must also ask what the motive is of the other party. It can prove quite disheartening.

The point of this blog is of course not about me. It is a revisitation of earlier blogs about the irrelevance of time. We may age and the date may change but most still live anchored in a specific point in time. It may be a memory or a relationship or a memory of a relationship. It drives how we feel today and what we do today. It may or may not be relevant to today. The ability to review and reset is, in my view, important to good mental health. Unable to detach from memories and relationships that anchor you out of time will make your life an anachronism. This is likely to make you feel alien to the present and unhappy in a vague unspecified way. It may make you long for a past that is no longer relevant (if it ever existed at all).

Looking at recent sociological and environmental developments I cannot help thinking that perhaps a collective reset is overdue. But if people find individual resets hard collective resets are even more challenging. There is no ‘history’ or ‘time’ in human existence. We collectively recreate the same social forms again and again. Technology changes but humanity does not. It seems we will continue to do this until we destroy ourselves and perhaps all organic life on this planet. Or perhaps fear that we will destroy ourselves might precipitate a reset.

Modern Monetary Theory: introducing the domestic sector

This blog builds on the primer by introducing the non-state domestic sector. It is a closed economy without a central bank. The state prints money to spend and takes back money by taxing or borrowing. The (non-state) domestic sector needs money with which to transact and store liquidity and wealth and thus has a demand for state printed money and state issued debt. How does this demand determine fiscal outcomes?

A balance sheet is usually presented as Assets(A)= Liabilities(L)+Equity(E). In national accounting this is stated as Real Assets(RA)+Financial Assets(FA)=Financial Liabilities(FL)+Net Worth(NW). Each sector has a balance sheet and this also must balance, hence:

RA(g)+FA(g)=FL(g)+NW(g)

RA(d)+FA(d)=FL(d)+NW(d)

(g) denotes the state sector and (d) the non-state domestic sector.

For every lender there is a borrower so across the economy financial assets and liabilities cancel;

[FA(d)-FL(d)]+[FA(g)-FL(g)]=0

and real assets must equal net worth (or national equity if you prefer).

So far this is just a set of identities (my equal signs should be identities).

What applies to levels or stocks must also apply to changes hence;

△[(FA(d)-FL(d)]+△[FA(g)-FL(g)]=0

where △ signifies ‘change in’. Clearly as a matter of accounting, if the domestic sector (d) increases its net financial assets, the government sector (g) must increase net financial liabilities. A moments thought makes clear that if the domestic sector is accumulating financial assets (has a surplus), the state sector cannot simultaneously accumulate financial assets (have a surplus). The idea that the state should run a budget surplus whilst expecting the domestic sector to do the same is clearly an inconsistent policy expectation. Yet typically this is what one hears politicians demanding.

The corollary is that the appropriate fiscal position of the state depends upon the desire of the domestic sector to hold money and bonds issued by the state. If the demand of the domestic sector is not met then collectively this sector will adjust economic behaviour until it is content. This will impact the real economy. This will be true at whatever level of capacity the economy is operating. If the economy is operating at full capacity there will be no inflationary pressure from a budget deficit if the domestic sector is happy to accumulate the resulting currency and government debt. This does not mean deficits do not matter. It does mean that the significance is determined by the domestic sector and not some arbitrary ideological fixation with balanced budgets.

It is important to note that MMT does not assert deficits are good and surpluses are bad. It merely observes what is necessarily true in a monetarily sovereign state; the state fiscal position is not independent of the desire of the domestic sector to hold money balances and government debt. This means the appropriate fiscal position cannot be determined without knowledge of this domestic sector demand. The idea that a balanced budget is always correct or that deficits are always inflationary is rejected. There is scope for debate about how the domestic sector adjusts when the demand for money balances and government issued debt is frustrated but the fact that it is this demand that ultimately determines the fiscal outcomes follows from the structure of the national accounts.

In my primer I suggested negative government bond yields reflect excess demand for such assets by the domestic sector. The negative real yields are having economic consequences. For one, they are boosting domestic sector borrowing in order to purchase property. They negative yields are encouraging leverage by the domestic sector. This is potentially destabilising and the source of future financial distress. The employment data suggests economies are close to full employment yet goods inflation is stable (asset price inflation obviously is not). The implication is that states have scope to spend more either by printing more currency or borrowing it in exchange for government debt. They can do this without inflationary consequences until yields ‘normalise’. Of course this begs the question of what ‘normal’ yields look like. What we can say is that negative nominal and even sustained negative real yields is not normal. There is a case for larger state deficits or smaller surpluses.

The next steps are to introduce a central bank, commercial banks, and the overseas sector. This complicates the detail and creates more options and possible policy positions but it does change the basic logic of MMT as outlined in this blog and my primer. One of the main problems is that proponents of MMT have used this framework to promote social policy objectives. They are right to use MMT because it is an internally consistent framework. It is important to remember though that MMT is simply an internally consistent framework and not a policy prescription.

S&P 500: Technical Update

Larry Fink, CEO of BlackRock, thinks equity markets will ‘melt-up’. An odd expression but we get the gist. Global growth optimism and easy central banks, he believes, will compel larger investors into equities. It is not an illogical view but then markets have their own logic. The recovery from the long-term uptrend (see chart below) was swift and impressive and perhaps pushing on to a new high is a reasonable expectation. But there is a problem.

S&P 500 Monthly


The RSI (the lower chart) is flashing dangerous divergence. Progressive highs are being achieved with less and less momentum. It is quite likely that a new high, if achieved will be so achieved without the RSI breaking the downtrend. This will confirm the divergence and signal a bias to the downside. Rather than a melt-up I rather fear a false break and a subsequent melt-down. This could happen even if growth is good and the central banks remain easy. It reflects the logic that markets follow (for whatever reason).

Most people are rather sceptical of charts and financial theory suggests they are the equivalent of astrology. Ironically I have seen astrology used to predict markets and with some success. I prefer the plain vanilla chart tools. Moreover I have been providing a taste of how they work in recent blogs involving the oil price and Lloyds Bank. Read the blogs and the follow ups and you will find that they do work if used judiciously and correctly. My advice to Larry is he should look closely at the above chart and monitor the evolution. It looks quite dangerous and if the RSI proves a good signal (it usually does) we could end up at 1800. More a melt-down than a melt-up.

Modern Monetary Theory: A Primer

The term ‘Modern Monetary Theory (MMT)’ appeared to me on social media in January. On investigation I discovered that not only had I been writing prose in my blog but also within the framework of MMT. Who knew? The great irony is that MMT is anything but modern. I ignored it at first since I was using the same framework in my own blogs, though different language, until a reader (there are a few) prompted me to address the ideas directly. This is a first look at some of the ideas.

The basic concept is the ‘monetarily sovereign state’. This is a state that issues its own currency and settles liabilities and makes purchases in the currency that it issues. We will ignore for the moment the institutional framework (Central Bank, Treasury) and just refer to the state. If the state wants to spend money it just prints currency and uses it to pay. Notice this differs from a commodity money system e.g. using gold or other precious metals as money. In this case the state must tax people in order to get commodity money with which to make purchases. In a ‘fiat’ money system it just prints money. Taxation is not necessary to raise revenue. Indeed taxation removes currency from circulation until the state spends it again. There are many other sound economic reasons for taxation and user charges but in a monetarily sovereign state raising revenue is not one.

The state could finance its service provision and activities simply by issuing currency. It need never tax anyone or charge for anything. The restriction on the state is not money but the real economy. What can it produce when presented with demand backed by currency? If the state spends too much it might push the economy to ‘capacity’, a difficult concept to which we will return in later blogs (and already discussed in earlier blogs). Moreover, individual economic agents may become reluctant to accept fiat currency in payment, at face value. The non-state sector must be accumulating fiat currency and it may decide it does not collectively wish to accumulate any more. Taxation and user charges provide an additional useful function of ensuring that fiat money continues to be accepted at face value. It can be used to pay taxes at face value and the taxes remove currency from the system. Taxes are not necessary but they are sufficient to ensure the currency continues to be accepted at face value.

MMT has at its core the above characterisation of the economy and the relation between state and non-state sectors. The government has not borrowed as it has no need to borrow. It does not need to tax to spend though there are many reasons, including ensuring currency circulates at face value, why it should tax. The constraints on the economy are real not financial. The constraints on the state are real not financial. This is a gross oversimplification but it does serve to lay bare the true situation for a state that issues its own currency which is accepted by the population, at face value, in exchange for payment by the state and other individuals. A lot can be understood from this simple framework.

First, the state cannot default on liabilities denominated in its own currency unless it so chooses. It just prints money and pays up. Second, borrowing by the state soaks up currency in circulation to be used again by the state. It also gives the non-state sector a different type of asset (currency being a current asset) that might serve as a store of financial wealth and facilitate deferred consumption. The state need never default on these state liabilities because it can simply redeem them with currency in the future.

One of the oddities of the post 2008 period has been negative bond yields on government debt. Why would someone hold a bond that cost them money to hold when they could hold the same currency at zero cost? My answer in several blogs has been that the institutional mechanism for holding currency (the banking system) has rendered currency above a certain amount no longer free of default whereas direct holding of bonds remains default free. Currency deposits over the insured amount are simply loans to banks and thus not default free now that the concept of not-too-big-to-fail has become current. The negative yields reflect the excess demand for default free assets and the inability to hold sufficient currency in a default free deposit.

This framework also lays bare the futility of QE. The central banks have collectively reduced the supply of the default free assets at a time of excess demand for such assets. This has not boosted spending but rather increased the price of risk free assets and generated negative yields. A more effective policy in terms of boosting demand would have been for the state to issue more bonds (meeting demand) and spend the proceeds. This of course is not politically possible because everyone has become obsessed with ‘balanced budgets’ and reducing government debt levels. Political irrationality is not the fault of MMT. The importance of MMT is that even in its bare bones form it reveals the futility of a lot of macro policy prescriptions.

The main criticism of MMT is that it is a prescription for hyperinflation. One could counter with QE and balanced budgets is a prescription for secular deflation. Getting inflation up since 2008 has been quite difficult and has basically failed. In Japan it has been failing since 1989 and they have even tried deficit financing! The relationship between currency in circulation and inflation is clearly not what textbooks suggest. We now have ten years of evidence to support this view. I suspect we will get many more. MMT says that the correct policy for a world economy that has capacity is for monetarily sovereign states to print money and spend it. If inflation starts to accelerate then it is time to stop and reverse. The constraint is the real economy and how it generates inflation and not the amount of money in circulation. In MMT inflation is also a real phenomenon not simply a monetary phenomenon.

Two caveats I would add. First, the greening of economics. The axiom of economics is that more growth is good. The condition of the planet suggests this axiom must now be abandoned. There is good growth and bad growth and much more attention must be given to the quality of growth. Maximisation is no longer sufficient. Quality is now the priority. Second, inequality is a serious problem. The market system is quite arbitrary in its equality outcomes and there seems to be a growing polarisation of wealth. This is having adverse political consequences as well as ultimately adverse economic consequences. MMT per se has nothing say about either but it is a framework that can be used to address both issues. Perhaps it should. The purpose of this blog was to introduce the core idea of MMT and demonstrate how it links back to my earlier blogs and how productive a framework it can be. Future blogs will develop the ideas in a little more detail and with more rigour (well that is the plan).

The Unbridgeable Divide

The UK is still in the EU. I confess I am slightly surprised. It seemed plausible that either one side or the other would have capitulated by now. Instead the UK parliament seems stuck in a remake of ‘Groundhog Day’. So, what now? The answer is no one really knows. The DUP will not contemplate anything that raises any risk of a border down the Irish sea. The ERG want nothing to do with the EU. A large cross-party group would prefer to stay in the EU. Both Tory and Labour Remain committed to restricting freedom of movement, which rather limits the options.

The population are also divided. There is significant minority that is violently opposed to having anything to do with the EU. There is an even bigger minority that just do not want to leave (judging by demonstration numbers and petitions). In between there may be a lot of people that are simply past caring. If we had another referendum tomorrow on a simple in or out basis it is likely it would be marginally in favour of Remain. Is this any more decisive than the original referendum? Previous blogs have discussed why the original referendum was insufficient of itself to justify triggering Article 50. Yet once triggered this has become irrelevant. Pandora’s box has been opened and as in the fable only hope remains inside. Triggering Article 50 opened an unbridgeable divide in the UK population. Whatever happens this issue will not go away for decades.

Theresa May negotiated an agreement to take us out of the EU. Parliament rejected this agreement 3 times. The default position is we will leave on April 12 without an agreement in place unless something intercedes. The ERG are happy with this as are many Leavers. There will be painful economic and social dislocation if this occurs. No amount of bluster and hopeful assertion will alter this. Both business and organised labour are united in lamenting such an outcome. Parliament has 12 days to come up with an alternative. There is no obvious majority for an alternative.

The Labour leadership is still committed to leaving in some form but seems to prefer a closer relationship with the EU (a soft Brexit). It is however growing warmer to the idea of combining any withdrawal agreement with a confirmatory referendum. This is sensible and frankly we would not be in this precarious position now had this approach been taken from the start. The original referendum resulted in a marginal vote in favour of some ill-defined notion of leaving. May’s agreement gave that idea form and importantly a form the EU would accept. It was logical and democratic to ask the people if leaving with this agreement was acceptable with the option of remaining if not. Leaving without an agreement was never an option as it is tantamount to national self-harm and no government or responsible parliament could sanction this. It seems to me that if something is agreed (a big if), it will need to be subject to a confirmatory referendum if it is to have any legitimacy.

The problem is that whatever happens the situation is not going to be resolved. If we leave many will lobby to rejoin. If we remain the campaign to leave will flare up again and possibly with violent spasms. UK politics will be blighted and irrevocably changed in an unpredictable way and probably continue to be dominated by this issue for decades to come. Individual relationships will be affected by attitudes to the EU in a profound way. The 2016 referendum changed the UK in an unknown way and we must now move into a somewhat foggy expanse.

After the Withdrawal Agreement

May’s ‘revised’ withdrawal agreement was rejected by Parliament yesterday. In fact it was not a revised agreement which is why it was rejected. Is that the end of it? Not necessarily. Today Parliament votes on whether to exclude the possibility of a no deal exit. If Parliament fails to exclude this possibility then we will experience an abrupt rupture of EU membership with all the painful consequences that this word implies. The expectation is that Parliament will vote to exclude a no-deal exit from the EU. However, even this does not entirely eliminate the possibility. A no-deal exit is the default position. Wishing it away will not do. Something must replace the default.

If Parliament declines to endorse the default position then a third vote on Thursday will decide whether to ask the EU for an extension of the Article 50 period. If Parliament chooses not to ask then the default position comes back into contention. The only alternative would be May’s withdrawal agreement which could be put to Parliament again. Presumably, if Parliament rejects no-deal and rejects an extension, May’s withdrawal bill would be expected to pass. It is likely therefore that if Parliament rejects the default position it will also vote to ask the EU to extend the Article 50 period. Confused? You will be.

The EU need not agree to the request for an article 50 extension. Once again the default position (now excluded by Parliament) and May’s withdrawal agreement are the only two possible options. Logic dictates May’s withdrawal agreement will be the choice. The EU will agree to an article 50 extension if the UK government offers a strategy for resolution with a material probability of not ending in the default position. Otherwise why waste more time? What could this strategy be?

Parliament could explore other withdrawal agreements that would be acceptable to a majority in parliament and to the EU. This would presumably be what some describe as a ‘softer’ Brexit. If no majority can be found for such an agreement then parliament would need to propose an election strategy. Either a general election or a referendum. Ironically neither need necessarily prove decisive. Imagine if another referendum resulted in 52% in favour of remaining in the EU. Would this be an end of the matter? I doubt it. So what then, best of 3? The EU is unlikely to agree an extension beyond the European Parliament elections in May so there is very little time to prevaricate. One mistake and the default option, or May’s deal, will come back into play.

The role of the DUP has been critical in this. Their concern was never the backstop but in what it might result. They needed to be sure that a UK government did not at some point try to exit the backstop by putting a border down the Irish Sea. This would be a de facto united Ireland. The only way to avoid any such possibility is to avoid any temptation. Hence their opposition to the backstop.

So is May’s deal dead? Clearly not. If Parliament reject a no-deal and embark on a delay, the end result might still be no-deal or May’s deal. May’s deal will most likely win. Parliament must either find a deal acceptable to Parliament and the EU before the EP elections or resort to an election of some kind before this date. The outcome of elections is never certain nor necessarily decisive. This is why we are in this mess.

Perhaps the most poignant comment comes from Rory Stewart, the Minister for Prisons. The 2016 referendum has fundamentally changed the nature of the UK and its relationship with the EU. It is not possible to simply ‘Remain’ because things cannot be the same. The genie is out of the bottle, the can of worms and Pandora’s box have been opened. We are in a different world and the least damaging way forward is to acknowledge this as fact and look for a workable path. This means leaving with a deal that keeps us as close as possible to the EU as we can achieve. The future is about shaping our relationship with the EU to meet the particular needs of the United Kingdom. It is with a heavy heart that I have come to much the same conclusion as Stewart.

Dual Citizenship and the Home Secretary

The Begum case has highlighted the ‘second class’ status of dual citizens in the UK. However, it is not a right-wing Tory plot. It originates in legislation introduced by the Blair Labour government in 2002 in the form of the Nationality, Immigration, and Asylum Act ( I elaborated the implications in a published letter to the Daily Telegraph). The current text of the Act (these acts are always being amended) can be found http://www.legislation.gov.uk/ukpga/2002/41.

Part 1, section 4 deals with deprivation of citizenship and amended section 40 of the British Nationality Act, 1981. It states ;

The Secretary of State may by order deprive a person of a citizenship status if the Secretary of State is satisfied that the person has done anything seriously prejudicial to the vital interests of—
(a)the United Kingdom, or
(b)a British overseas territory.

It also states;

The Secretary of State may not make an order under subsection (2) if he is satisfied that the order would make a person stateless.

It gives the Home Secretary, an elected official with political motivations, the power to deprive a British Citizen of their citizenship provided it does not make them stateless. He need only be ‘satisfied’ that they have acted in a manner ‘seriously prejudicial to the vital interests of’ the UK. This can of course mean anything the Home Secretary wants. It is a huge arbitrary legal power in the hands of a politician. There is no judicial involvement.

If a British Citizen acts in such a way and has no other citizenship, this person must be dealt with in the British courts. The outcome is subject to all the obligations and protections of British law. The unitary citizen has the right of recourse to British courts but the dual citizen can, at the discretion of the Home Secretary, have the citizenship revoked. Hence, the dual citizen has less rights and is second class.

The Begun case brings home what this can mean if we can get past the fact that, prima facie, excluding her from the UK may be advisable. Anyone that has right to citizenship elsewhere is exposed to the Home Secretary’s whims. One need not even be aware one has such a right let alone have registered to take up the citizenship. A similar problem afflicted several Australian MPs in the recent past. Moreover, actions that can be argued to be prejudicial expose dual citizens to perils that unitary citizens are not exposed. Those that have rushed to disinter grandparents and gain dual EU and British citizenship might want to keep this in mind. This situation was the creation of New Labour and not the Tories.

Lloyds Bank

I do not normally focus on individual stocks. There is too much that I know I cannot possibly know. I tend to diversify and take a passive approach to equity investment. My main decision is on asset allocation which is to say my split along asset classes (Cash/Bond/Equity/Property/Commodity). The most important decision at any point in time is of course cash versus risky assets. However, I do run an individual stock portfolio as a hobby and in this I try to pick out stocks that look cheap. Lloyds Group looks cheap but then it has looked cheap for a very long time. My opinion counts for little but some observations do provide food for thought.

First, Lloyds is very much a UK bank in the sense that it derives most of its revenue from the UK economy. The prospect of leaving the EU has depressed the share price because of the risk of a badly managed departure, with adverse consequences for the UK economy and in particular the UK property markets. Mortgage lending is and important element of the Lloyds revenue stream. Much uncertainty and bad news is thus already reflected in the price. The latest Lloyds results (2018) and the accompanying statement suggest the Lloyds management are not especially worried about further adverse consequences from leaving the EU. This is notable because management have much to gain for effectively getting their excuses marked out early.

Second, the management has increased the dividend (always a positive). They will pay 3.21p for the full year. This is 5.5% of the latest closing price. If you look at the banking page you will discover that they will pay you 0.65% p.a. if you deposit your money for two years with the bank. It is no wonder they are reporting a higher net interest margin (cost of funding versus lending charges) at 2.93%. But can they sustain the dividend? Well, as always things can change but the earnings per share are 5.5p. The dividend is comfortably covered by earnings and they have plenty of capital (they are buying back more shares). The management are confident they can keep it up.

The share price has broken the recent downtrend and is quite capable of moving back to the 65-68p range. Indeed this is probable from a chart perspective. There may still be hidden problems related to past misdemeanours but at present these legacy issues appear to be diminishing in significance. My own exposure to Lloyds is relatively high. It is my largest individual holding so adding would be inappropriate. If I did sell what would I do with the cash? Investing in fixed deposits with challenger banks might yield 2-2.2%. Think I will stick with Lloyds Group shares.

Postscript 17 04 2019

As suggested…
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