April 21, 2008 | posted by Michael Baxter in Banking, credit crunch |

So, it’s out.

The Bank of England had been going on about moral hazard and how you can’t reward failure.    The RBS had repeatedly said it did not need to raise more to fund its purchase of ABN Amro.   As for the rest of the banks, they were keeping mum.

But now the first two dominos are down.    There’s £50bn here from the Bank of England, £10bn, or so rumours suggest, there from RBS.     Now commentators are asking, who will be next?

The Observer speculated that total fundraising from British banks in the form of rights issues, or maybe injections from sovereign wealth funds too, could finally come in at £30bn.

So that £50bn from the central bank, and maybe another £30bn from shareholders and abroad, all in all that’s a total of £80bn, or $160bn.

The IMF recently predicted that total worldwide losses from the credit crunch could eventually move within a whisker of $1 trillion, so actually, the amount being raised in the UK could finally come in at around 20 per cent of that total.

Meanwhile in the US, the Fed has dished out around $158.95 billion so far in a scheme not dissimilar to the Bank of England effort.  

As for the US banks, Citigroup has raised around $30bn, Merrill Lynch around $12.8bn.  Other banks, such as Lehman, have raised less – $4bn in the case of Lehman.

The other big fund raiser was Swiss bank UBS, which is raising around $15bn.

Then throw into the pot the $150bn tax credit in the US, and it seems so far, while the IMF reckons around $1 trillion will fall out of the pot, around half that amount is coming back in. 

So actually, that’s not bad.

No wonder the markets have remained relatively bullish.    The Dow was up 228 points on Friday, at 12849.4 it closed at the highest level since January 3.   At this rate the Dow could even go past its start of year position of 13043.

The FTSE 100, on the other hand, is still way off that pace. In fact on Friday it merely closed at its highest level since the end of February.

The markets had further reason for cheer. Losses at  Citigroup in its first quarter were a mere $5.11 billion, compared with a profit of $5.01 billion a year earlier.  Meanwhile, Merrill Lynch lost just $1.9bn –  with a trivial $6.6bn in mortgage write-downs.

Pah.  What crisis – that $1 trillion loss will soon fade away in a puff of smoke.

Then again, smoke and mirrors can’t really solve the problem.

You really can’t magic real money out of nothing.  Central banks can of course print money, but that just leads to inflation.

Markets may be celebrating that debts are being pushed out into the open – and balance sheets are being shored up.   But looking forward, one of three things will happen.

One possibility is that banks will go back to their old ways. The moral hazard argument will stand, and because they have not been punished for their past misdeeds, they will make the same mistakes all over again.  But next time, consumer debt will have grown even further, and the next crisis will be even worse.

The second possibility is, chastened, banks will rein right back.  Their balance sheets may be fixed, but they will be reluctant to repeat the same lending mistakes.  But they will go too far, and in the general climate of tighter lending, businesses will be starved of the cash they need.  That could in turn lead to a secondary crisis as a result.

Alternatively, they could find the Goldilocks point.  They will be more cautious, yes, but not so cautious that business is starved of its life blood.

Economic performance over the next couple of years will depend on which one of those three possibilities wins out.