Notes on Persuasion

This is great! :

http://climateprogress.org/2008/10/13/why-scientists-aren’t-more-persuasive-part-2-why-deniers-out-debate-smart-talkers/ 

If the banks need any more public money, the government should buy high street branch networks and create (and then slowly privatise) a 'good bank'

The most straightforward way to solve the current crisis is bank nationalisation. There are a few reasons why the government might not want to take this path, one of which is the large overseas assets and liability of UK-based banks. The sovereign has limited fiscal credibility; the key to avoiding future hyperinflation is not biting off more than it can chew. It should focus on the UK and on creating a 'good bank' to promote future lending.

I never suggested that the government buy stakes in banks, as the UK government did late last year. However, in retrospect it seems to have been a good plan. The systemic collapse of the banking system was forestalled.

Of course, most of that money went into a black hole. But the government did end up by owning large parts of the banks' equity, which might be worth a lot in the future if the banks recover. £37 billion for pure upside on say £2trillion of assets isn't too bad a deal. And having an equity stake is clearly not the same as guranteeing the banks liabilities for free. Limited liability still applies.  

However, the government obviously has certain responsibilities in the UK banking system - it needs to guarantee the deposits of UK savers, and it needs the banks to lend enough to keep the economy going.

To summarise, the UK government has two clear requirements, both UK based
a) 'Get lending going again' to UK individuals and companies
b) Guarantee the deposits of UK individuals, charities and (probably) companies

These objectives can be acheived by a transaction that involves:
a) Buying the branch networks of the major UK banks (needed to 'get lending going') 
b) At the same time, taking on the liabilities of the domestic depositors
c) Taking on the 'good' assets in the corporate lending and mortgage book

The old banks would be left with more cash (from being able to sell some of their tangible assets). This would leave a deleveraged, cash-rich rump (including in effect an overseas lending unit) which might die slowly.

HBOS would be a good example. The government should take on the branch network, and the brand and the domestic depositors (liabilities), and the good parts of the domestic mortgage book (assets); but none of the 'toxic debt'. This would then be a 'good bank'.

The government could then progressively sell stakes in the 'good bank' to private investors.

The main risk for this plan, would be that if only some of the branch networks were bought, there might be a run on the other, privately owned banks. 

There would still remain the question of what to do with the remaining 'bad bank'. Few might lend to it; but in any case few are lending to the big banks now anyway. Bankruptcy is one option, but it usually involves plenty of money for lawyers.

If the banks are insolvent, they need to be declared bankrupt. Bankruptcy has risks; the main one being the huge 'costs of financial distress' (Lehman Brothers will keep its' liquidatorsarmy of lawyers and accountants busy for many years) the advantage of the government buying the 'good bank' first, is that systemically important assets (uk depositors, interbank lending) can be trasferred into the public sector first.

New lending must be seperated from existing lending. Current government thinking suggests that we need a government-backed good bank much more than we need a government-owned bad bank. And taking on the bad assets is socialising private risks - not a good idea. Better to create the good bank first, including both high-street and capital-markets elements. Use the good bank to get lending going and to 'look to the future'. The remaining bad bank would be cash rich with a more volatile and non-domestic balance sheet and fewer tangible assets. It would have in effect a skeleton team remaining. If insolvent it would wind itself up naturally.

Time for a good bank

Balance Sheets and Foreign Lending
The problem with the current high street banks is the sheer size of their balance sheets. 
The Royal Bank of Scotland in particular is a concern: it has assets of around £3.7 trillion. Quite a lot of this is abroad.

A small change in asset quality will lead to a large loss. This means that their scarce capital will be tied up insuring themselves against existing losses, rather than being able to be deployed to cover new lending.

This poses problems for the government too. If the banks were small domestic institutions with most of their assets being domestic then that would be one thing. But they are large international institutions with large operations abroad. The governement will have enough on it's plate insuring uk depositors (given the matched up the uncertain value of uk mortgages), without having to insure ABN's depositors (matched up against the uncertain value of ABN assets).

Good Bank / Bad Bank
The logic of a good bank / bad bank solution to the British banks is that the good bank can lend without being infected by the uncertainties associated with the 'bad bank'. There is a way of achieving this, which I will come to in the next post.

Next Steps for the Banks?

In my previous post, I dealt with what to do if the banks are solvent. But it seems now that the banks are not solvent; at least they will not be solvent in the forseable and credible event of further major losses on their assets (their loan books). What to do with insolvent banks is difficult. 

We need a plan of action to deal with these banks.

The easiest and most straightforward plan are nationalisation or bankruptcy.  

At one extreme is full bankruptcy. Creditors of the bank would be wiped out as seen by the Lehman brothers; this leads to lots of money for lawyers. This is probably a bad move because of the interconnected nature of the banking system; there is lots of paper and therefore lots of legality.

At the other extreme is nationalisation with full reimbursment of those who hae deposited money. The issue with this is that the banks may have very large credit risks, and the UK sovereign may not be able to bear all of these risks. 

Somewhat in the middle is restructuring of the existing banks; swapping the creditors into equity.

After nationalisation, the bank would be seperated into a bad bank and a good bank. The good bank would continue to sell.  Bad banks are equity investments. They contain assets but no lending capability. 

I think the government needs to assume lending capabilities itself. It needs to create some good banks. There should be at least one good bank.

What is the national debt? What are the debts of the UK banks?

Since we have seen a certain amount of creeping nationalization, it is important to realise the potential public liabilities that the public sector might be taking on, in comparison with the total government debt.

First: How much is government debt?
Gross government debt is a stock of how much the government owes the private sector.
The value of gross public debt is about three quarters of a trillion pounds (£774bn); the net debt about £600bn) http://www.hm-treasury.gov.uk/psf_statistics.htm
Pensions liabilities could be added to this (maybe about £530bn). http://www.telegraph.co.uk/finance/2944530/National-debt-may-soar-above-andpound1,000bn.html
PFI liabilities are around £60bn (capital value)-£180bn (total repayment)
So it seems that rougly speaking, the UK public debt is around £600+£530+£100 or £1.2trillion. This is a stock.

(UK GDP (a flow) is about £1.5 trillion. http://www.statistics.gov.uk/STATBASE/tsdataset.asp?vlnk=574&More=N&All=Y . Therefore the total UK public liabilities are about 80% of the flow of income into the british economy. To make the stock and flow comparable if we payed a 5% interest rate, interest payments would be around 4% of GDP.)

Second: What is the value of the liabilities of the banks?
Now let's compare with the balance sheets of the banks (I'll keep the two bits of the Lloyds banking group seperate):

Lloyds TSB
Assets of £706bn, Liabilities of £681bn. (net assets of £25bn).

HBOS
Assets £442bn, Liabilities of £370bn

Barclays
Assets £924bn; Liabilities £900bn.

RBS

So, the conclusion is total liabilities
UK Gross Public Debt £770bn
Public Pensions £530bn
PFI £100bn
Total Gross Public Debt £1400bn

Here are the Gross Banking Liabilities (in brackets, the loss incurred for a 10% fall in asset values due to bad debt):
  • Lloyds TSB £680bn (£71bn)
  • HBOS £370bn (£44bn)
  • Barclays £900bn (£92bn)
  • RBS: over £1tr
These liabilities are large in comparison to the UK existing public debt (£700bn).


How Sensitive Is The Climate

Why 'Fast Feedbacks' are quite slow and 'Slow Feedbacks' might be rather fast.

I've just been reading Hansen (2007): http://www.planetwork.net/climate/Hansen2007.pdf
It has lots of interesting stuff about climate sensitivity.

The climate sensitivity is the temperature response of the whole climate to a forcing of greenhouse gases. We know that there are two basic sorts of feedback processes going on in the climate. Firstly we know that as the temperature rises, relative humidity will stay roughly constant and thus absolute humidity will increase. This leads to more water vapour in the air; and water vapour is a strong greenhouse gas. Higher temperatures also has an ambigous (to this author) effect on clouds. The sum of all these atmospheric effects yields the 'Charney' definition of the climate sensitivity which is the equilibrium temperature rise from a doubling in CO2 concentrations; assuming that the land albedo and carbon (CO2/Methane) sinks stay constant. (of course they don't stay constant; we will come to this). This has been argued to be close to 3Celsius (3C) for a doubling of CO2 or 0.75C/(W/m2)*. [*A doubling of CO2 gives an increase in radiative forcing of about 4W/m2, so multiply the C/(W/m2) by 4 to get the temperature change for doubling CO2]
Hansen et al. (1993) calculated the ice age forcing due to surface albedo change
to be 3.5 C/(W/m2). The total surface and atmospheric forcings led Hansen et al. (1993) to infer an equilibrium global climate sensitivity of 3C for doubled CO2 forcing, equivalent to 3/4 +/- 1/4 C/(W/m2). This empirical climate sensitivity corresponds to the Charney (1979) definition of climate sensitivity, in which ‘fast feedback’ processes are allowed to operate, but long-lived atmospheric gases, ice sheet area, land area and vegetation cover are fixed forcings. Fast feedbacks include changes of water vapour, clouds, climate-driven aerosols1, sea ice and snow cover. This empirical result for the ‘Charney’ climate sensitivity agrees well with that obtained by climate models (IPCC 2001). However, the empirical ‘error bar’ is smaller and, unlike the model result, the empirical climate sensitivity certainly incorporates all processes operating in the real world.

This 'fast feedback' is not all that fast however... The fast feedbacks being slow: 50% of the climate response happens in 30 years and the rest takes 1000 years. So we see in immediate terms (net of the cooling effect of aerosols) about 50% of the climate change that we are likely to see.













Now to the 'slow' feedbacks, namely the ice-albedo changes from melting ice and carbon dioxide and methane releases. How fast are they? And how serious?

In answer to the 'how fast', the simple answer is we don't know. Traditionally, ice-melting has been seen as a slow process. But the old models may not be correct; as was shown by record melt rates in the early 21st century. Paleotological evidence points to times between the ice ages where sea levels have risen metres in a single decade. Hansen suggests that the relative stability of our epoch may have been to do with the fact that there was a zone of comfort between the melting of the great Eurasian and North American icesheets and the melting of Greenland and West Antarctica.

The second question is 'how much'. One approach is bottom up: you add carbon cycle causation to the greenhouse effect.
If the effect of temperature on radiative forcing is given by s and the effect of radiative forcing on temperature by g, the feedback relation is simply:
DT(with feedback)/DT(without feedback)= 1/(1-g*s). This amounts to 15-78% more warming (Cox and Scheffer 2007):
the feedback of global temperature on atmospheric CO2 will
promote warming by an extra 15–78% on a century-scale.
This estimate may be conservative as we did not account for
synergistic effects of likely temperature moderated increase
in other greenhouse gases.
But as the authors point out, this does not include the effect of everything working together.
What evidence do we have of everything working together?

A cursory inspection of the graph of greenhouse gas forcing:









shows:
a) A very high correlation (suggesting a strong link between greenhouse gas concentrations and warming)

b) Episodes of very rapid temperature change and ice melt (over the time scale of decades - e.g. the 'Younger Dryas' event.

c) a correlation between the two variables of about 3C/(W/m2)

Now the temperature shifts at the poles by about twice the global temperature change, we can imply a correlation of about 1.5C/(W/m2).

This is about double the 'fast feedback' 0.75C/(W/m2) predicted byclimate models and would imply a temperature change of six celsius for a doubling in CO2, twice what we have already found. But this is not the same quantity. It's not clear that the figure found by dividing the standard deviation of the Temperature graph by that of the Forcing graph is the quantity that Hansen asserts it is and that we want. What is going on?

So, following Scheffer and Cox, here is some basic theory of feedback loops...

Let's assume that Forcing (in W/m2) leads to temperature increases in Celsius (C). Let's assume both processes are linear:

g
Forcing --> Temp
\ /
<--
s

If we denote the initial change in forcing by f (before feedbacks)
and the final change in temperature by T (after feedbacks)
This gives T/f=g+g(sg)+g(sg)*(sg)...= g/(1-s*g)

What about the other direction?

s
Temp --> Forcing
\ /
<--
g


Here we observe only the final F and the final T
We see Forcing = (s+gs+gs*gs+...)t

F = t * s / (1-gs)

And T = t(1+gs+gs*gs+...)=t/(1-gs)
So F = s * T
T/F = 1/s

So if we observe T/F = 1.5 this implies that s = 2/3.

So the overall effect all depends on the overall strength of the feedback 1/(1-gs).

So ice core evidence provides us with information about the *strength of the Temperature-CO2 feedback* not on the overall greenhouse effect, including feedbacks.

The information about the gain of the whole system will therefore be gleaned from the size of the equivalent radiative forcing change that started the whole process off. If the huge temperature change and big CO2 increase was the result of a huge temperature forcing, this would imply that the feedback from temperature to CO2 was huge, but that the greenhouse effect was small.

Hansen's paper provides some very interesting evidence of the magnitude of the forcings from precession, but does not go so far as to come to an estimate of the 'equivalent' forcing implied by the Milankovich cycles. It is clear that the forcing on a global sense is small, but as Hansen points out, the effect at the ice age boundary is larger.

My conclusion supports the methodology of Cox and Sheffer over that of Hansen. However, it suggests that it should be easy to extend Cox and Scheffer to include other greenhouse gases and ice-albedo effects (by using the data that Hansen himself uses).

What is needed is to have a rough estimate of the magnitude of the original 'equivalent temperature' forcing (already including *local* ice-albedo feedbacks - since an insolation increase at the polar rim where ice is melting is clearly very effect; but *excluding* global feedbacks) that started the whole process off.

Hansen's paper hints at it but does not profer an estimate. His guess is probably a bit better than mine. Perhaps he should guess. An approximate answer to the exactly relevant question may be as much use as the exact answer to an approximately relevant question.