October 6, 2008 | posted by Michael Baxter in Banking | comments (0) |

Well, the men from the House of Representatives, they said Yes. And so this weekend, bankers everywhere breathed a sigh of relief – and unanimously agreed we could all get back to normal.

It is just that these days, normal isn’t what it used to be. In fact, this weekend saw banks around the world play a game of musical chairs. They got up and danced, and ownership changed, and in some cases changed again, but that feeling was left hanging. How many would be left standing when the music stopped?

The weekend of normality saw doubts creep in on the future ownership of Wachovia, the sixth-largest bank in the US. Originally it was to be bought by Citigroup, then at the end of last week the bank revealed that instead it had chosen Wells Fargo. But that left lawyers at Citigroup hopping mad.

It appears the problem is this. Under normal circumstances, companies for sale like to do a bit of flirting first, play the field, tease a few suitors. But it is not like that now, speed is the watchword, the price of no deal can be a failed bank. So you can’t have it both ways, you can’t expect your chosen suitor to jump through hoops at breakneck speed, and then decide that actually there is a better deal elsewhere. Normality is different now.

The weekend of normality saw a change in ownership of the bank Fortis. This is the bank that got rescued by the governments of Belgium, Netherlands and Luxembourg last week. Well, now, the French bank Paribas is to take control of the bank, oh, and by the way, the French bank’s major shareholder is to be Belguim.

Then in this weekend of normality, German’s second-largest property lender, Hypo Real Estate, found itself on the receiving end of a 50bn euro government-led bail out, after an attempt to rescue the bank, using private sector money only, failed earlier in the weekend.

Cast your mind all the way back to last week, that country-come-hedge fund, Iceland, nationalised its third-largest bank Glitnir. But in this weekend of normality, the idea was discussed to have Iceland’s trade unions agree to use pension funds to shore up the country’s banks.

In this weekend of normality, Italy’s second-largest bank, UniCredit, was reported to be fighting for its survival as it embarked on an emergency fund-raising drive.

And, if you can remember as far back as the previous era when things were rather extreme in the banking world, that’s last week, two countries, Ireland and Greece, announced they were guaranteeing 100 per cent of savers’ deposits at their banks. The two nations came under criticism, as savers looked to move their accounts to Irish banks. Well, in this weekend of normality, Germany, Austria and Denmark all chose to make similar guarantees.

Then this morning, the first Monday of normality, the Telegraph headlined: “Government should take control of money markets.” So, just to run that past you again, the Telegraph spoke up for nationalisation. Actually, in fairness to the newspaper, it was quoting Willem Buiter, former member of the Bank of England’s Monetary Policy Committee and now a professor at the London School of Economics. But even so, when the Torygraph gives that kind of oxygen to the idea of nationalisation, you know that this Monday must be the most extraordinary ordinary Monday ever seen.

But at least there was something rather ordinary about one extraordinary development.

Mandy is back. There is something strangely reassuringly normal about hearing the former EU trade commissioner talking about domestic issues. And this morning, Peter Mandelson warned: “The danger in this crisis is it may spark a new wave of economic nationalism, with each country looking for a ‘get-out-of-jail free’ card. People have to realise that selective or national approaches could lead markets to look to parts of the financial system in a distorted way.”

Ummm, come to think of it, maybe this weekend wasn’t so normal after all. Let’s see what our chancellor has got up his sleeve, and to find out, read the next article.

October 2, 2008 | posted by Michael Baxter in Banking | comments (1) |

You know what it’s is like arguing with a child.  You say,  ‘yes, you must,’  and then the child replies  ‘no, no, no.’  So you say,  ‘yes, yes, yes, yes,’  and the  ‘no’s  get louder and more frequent,  and then you end up threatening to take toys away from the child. Eventually,  after a cool off period,  in which the child is sent to bed,  you get your own way,  or at least,  sometimes you do.

Last night,  senators voted to accept the Paulson plan.  This time they voted 74 to 25 in favour of the plan.  Here is the curious bit,  the plan wasn’t changed by that much,  the only really significant change is that it has got more expensive.  And yet,  somehow it is thought this time it will get through.  Friday night is when we will know,  that is when the House of Representatives votes.  Last time it was 228 to 205 votes against.

 The consequences if the plan was voted down would be disastrous for the markets of course,   a negative vote would lead to massive falls on stock markets across the world.

So these are the changes to the Paulson plan,  and this is what is wrong with them.

First off,  the maximum guarantee for money on deposit is being increased.  Now,  you can have up to $250,000 on deposit in the US,  and if the bank goes bust,  your money is still protected.

Secondly,  there are going to be changes in tax breaks for US companies and individuals using renewable energy.  Just re-read that.  The Paulson plan mark 2,  designed to save the global economy from a catastrophic banking meltdown,  will include tax incentives to invest in renewable energy.  Now there is nothing wrong with the idea per se of tax incentives to use renewables,  but it is not exactly relevant,  is it ?  So the child won’t go get off the swing at the playground and you offer to buy her a milk shake if she does.

The plan will also see one year’s worth of extra relief from what’s called the Alternative Minimum Tax.  This scheme was supposed to tax higher income earners more heavily,  but due to inflation was hitting more people than originally intended.

The new plan is also supposed to put curbs on executive pay.

But really,  it is just tweaking.  This is a plan that was supposed to save the universe, and its modifications are really not significant.  Well,  they are significant in one way.  The original plan was 4 pages in length,  the revised plan 451 pages.  So,  at least US lawmakers are getting more reading matter for their money.

George Dubya is doing his best and has been getting on the blower, ringing Republican members of the House of Representatives,  and the salesmen reckons he has already got four more votes.  No doubt,  he has got some hot leads too.

One snag is that while both Republicans and Democrats are against the plan,  they are largely against it for different reasons.  So changes designed to appease some, may antagonize others.

Yet here is the odd thing.  The biggest worry with the first plan was that it was so expensive - $700bn.  The new plan will be more expensive.

But the fundamental problem is this.  It is still the wrong plan.  The Paulson plan still amounts to little more than a bigger version of all those others plans that were implemented to save banks in the early 1980s and 1990s.  View those previous plans from a longer-term point of view,  and it appears they have not been successful at all,  because surely the roots of this crisis lie in the solutions to the last crisis.

To work effectively,  capitalism needs failure.  You need to get rid of the dross,  and let poorly run businesses fail.

The snag is,  that a wholesale failure of the global banking system would lead to a major economic depression with all the horrendous social consequences of that.

The right plan, would be one that sees government money used to recapitalise banks,  in exchange for equity.  The equity would come at a massively discounted price,  it should do,  you always get bankrupt stock at rock bottom prices.  The shares will also be available to the public, and sovereign wealth funds.  This plan would be the right plan because firstly it deals with the fundamental problem of solvency.

It would also be the right plan  because it punishes the owners of the banks,  and thereby makes it likely the same mistakes won’t be repeated in a hurry.

It is also the right plan because it means tax payers will enjoy a share in the recovery of the banks,  when this happens.

The reason why this eminently superior plan is not being considered is because it smacks of socialism.  But that is really missing the point. Socialism is when companies are nationalised,  because it is felt that the state should own business because it is socially just, and because the free markets can’t be trusted.  

Rather, the plan described above would just be temporary,  designed to reduce the social costs of capitalism working efficiently. Capitalism says investors in a business should be rewarded.  Because the Paulson plan does not reward tax payers with equity,  it is in fact the antithesis of capitalism.

It is as if socialism has become a naughty word - and anything that in any way bears any resemblance with that word is bad.  It is like a asking a parent what sex their child is,  and then another child who overhears the conversation sniggers because they heard the ‘s’ word.

The reason why the right plan is not being considered,  is down to semantics, and for that reason,  US Congress are making a big mistake.

October 2, 2008 | posted by Michael Baxter in Banking | comments (0) |

If you don’t think madness is rife on Wall Street, consider this.

A heated debate is raging on Wall Street over the way accountants do things.  This may not seem that serious to you,  and yet it cuts right to the heart to the matter of the credit crunch and banking bail outs.

When companies value their assets they are supposed to use something called  “mark-to-market.”  So,  if one company is forced to sell its assets as part of a fire-sale,  then all companies with similar assets  are forced to revalue them,  in accordance with this fire-sale price.

It all boils down to mortgage securities.  Their value is plunging,  because those banks that need the money desperately are being forced to sell on the cheap.  Therefore,  all banks with these types of mortgage securities have to make write-downs,  creating losses, and then creating a banking crisis.

So, all we need to do to end this financial crisis,  is let banks put a more sensible value on their mortgage securities.

But here is the snag with this idea.  Who is to say what the right value is for these assets ?

The only way you can determine the value of assets is through market valuation.  Those who want to remove this rule are somehow suggesting the markets are wrong,  and they are right.

But it is curious,  isn’t it ?  When these securities were rising in value, you didn’t hear many complaints then.

The key, though lies with transparency.  There has to be a method for valuing assets that has some basis in reality.  A move towards some other method of valuing these assets has the makings of the next Worldcom and Enron controversy.

September 30, 2008 | posted by Michael Baxter in Banking | comments (2) |

So,  when the history books describing this time are written will they really look back at yesterday’s decision by Congress as the pivotal moment?  Will the decisions of those 228 Law makers really send the global economy into a 1930s style depression?  Was this really a one off opportunity to fix the problem?

Last night,  EU Commissioner Peter Mandelson was interviewed on BBC2 Newsnight.  He said  “I feel they’ve taken leave of their senses and I hope that in Europe we will not see politicians and parliamentarians replicating the sort of irresponsibility and political partisanship that we have seen in Washington.”

And yet,  consider this.  The Paulson plan had many flaws.  There are strong arguments to suggest it was the wrong plan.  Some say,  well,  at least it was a plan.  Any plan is better than no plan.

But is that right ?

Most successful business people will tell you it is a mistake to make split second decisions. If you enter into a hire purchase agreement to buy a new TV,  you are given a seven days cool off period.  If you are buying a house,  the lawyers seem to do their best to slow the whole process down,  with their due diligence.  In business,  it sometimes feels as if lawyers call the shots – their  “moreovers”  and  ”whereupons”  can be irritating,  they can slow transactions down,  but most would agree they are essential.

Sometimes you may find yourself under pressure.   We are usually suspicious of take it or leave it deals.  Here is some advice for a would be buyer subjected to a high pressured sales techniques: walk away.  Anyone who tries to persuade you the deal won’t be available tomorrow is usually bluffing.

Now we are told we face financial Armageddon.  That it is 1929 all over again,  that yesterday’s no vote by the House of Representatives spells the end of prosperity.  That the US is a third world economy in the making.  And markets do their headless chicken impersonation.  Paulson wanted $700bn,  yesterday the US stocks markets had more than $1trillion knocked off their value,  therefore goes the argument,  Congress’s reticence has already cost more than the money Paulson wanted to spend. 

Yet,  you know that’s not true.  Markets rise and fall,  even the US government has only limited opportunities to spend $700bn.

Right now,  what is really called for is thought,  a considered response to the financial crisis.  Those who can keep their head while others panic,  should be the ones who set the pace.

Yesterday’s decisions by Congress does not spell disaster.  And this is why.

The first thing you need to bear in mind is this.  Congress acted the way it did,  yesterday because that is what the electorate wanted.  Your average US American was not impressed by the Paulson plan.  Bankers have lost the confidence of US citizens,  well they have lost the confidence of most citizens everywhere,  and this was a plan hatched by an ex banker.  Bankers failed to see this crisis coming,  and former chairmen of Goldman Sachs turned Treasury Secretary are no exception to this.

George Dubya’s loss of credibility in the US is almost as bad as the loss of credibility he suffered from in Europe a few years ago.  If George likes the plan,  it must be bad,  went the reasoning.  This point is perfectly illustrated by the comments from one US politician, comparing the argument that the Paulson plan will save the economy with claims that there were weapons of mass destruction in Iraq.

But,  set aside the emotive response,  there were major flaws with the Paulson plan.

Nouriel Roubini,  high profile Professor of economics at New York university pointed out that in an IMF study of 42 systemic banking crises,  only seven,  Mexico, Japan, Bolivia, Czech Republic,  Jamaica,  Malaysia,  and Paraguay,  saw the government purchase bad assets,  in the style of the proposed Paulson plan.  None of these seven Paulsonesque plans were especially successful.

By contrast,  the banking rescue that seems to have been the most successful – if you like the model rescue,  was seen in Scandinavia.  This saw no buyout of bad debts,  instead,  the governments in Sweden,  Norway,  and Finland,  injected capital into the banks,  and in return the governments acquired substantial equity.

Yesterday,  when it was assumed the plan would go through,  Capital Economics said  “The root of this crisis is not the lack of liquidity in that market,  it is the lack of capital in the banking system.  As it stands,  the Treasury’s plan to buy the illiquid assets on banks’ balance sheets will do almost nothing to prevent the destruction of bank capital and the resulting reduction in lending and economic activity.  We still expect the economy to endure a torrid recession over the next year,  forcing the Fed to slash interest rates to only 1.0 per cent.

“In using the government’s money to buy assets,  the Treasury will be working against the leverage on banks’ balance sheets.  What the Treasury should be doing is working with the leverage,  using its money to inject capital directly into the banking system.”

Mr Roubinu,  perhaps one of the biggest critics of the Paulson plan said  “the claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize banks has absolutely no factual basis or justification.  This way of recapitalizing financial institutions is a total rip-off that will mostly benefit – at a huge expense for the US taxpayer - the common and preferred shareholders and even unsecured creditors of the banks.”

The big snag with the Paulson plan,  of course,  as was pointed out here yesterday,  is that it is based on the assumption that mortgage debt is undervalued.  The Treasury was in effect supposed to second guess the market,  buy assets on the cheap and sell them at the market price down the line.

But supposing Paulson estimate of the true value of debt was wrong.  His plan mounted to little more than asking tax payers to fund speculation.

This is what we know.  The global finance sector is in crisis.  The last few days has seen two of the largest US banks go down – Washington Mutual and Wachovia,  (Wachovia did not go bust as such,  it was bought by Citigroup at a rock bottom price.)  In Belgium,  within hours of the nationalisation of Fortis,  news broke that the Belgium bank Dexia SA,  the world’s largest lender to local authorities was on the verge of collapse.  In Iceland,  Glitnir,  the islands third largest bank has been nationalised.

But the underlying problem behind all of this is the collapse in house prices - around the world.  The house prices crash was not caused by the credit crunch,  the relationship is the other way round.  Implicit to the Paulson plan is assumption that house prices will stop falling – then go up,  which in turn will get the US tax payers off the hook.

But this may not be the right thing for the long-term.

The best possible solution is for all governments,  US,  UK,  and Eurozone,  to inject banks with capital - and in return acquire substantial equity.  When things recover, maybe in several years time,  government shares should then be sold.   The rejection of the Paulson plan was the right thing, because a better plan was needed, and if that takes a bit more time, then so be it.  

September 15, 2008 | posted by Michael Baxter in Banking | comments (1) |

Every century a one in a hundred years event happens. Has anything more obviously true been stated here? But here are two interesting angles on that statement. Maybe as far as the financial world is concerned that one in a hundred years event occurred last night and this morning. Here is the other interesting angle, these days, one in a hundred years events seem to occur a lot more often that that.

Not so long ago, AIG was the largest insurer in the world. Now rumours say the American International Group is hoping for support from the Fed, as well as seeking to raise money from investors with an eye for a bargain, while simultaneously selling off assets.

Not so long ago, John Thain, the boss at Merrill Lynch said that the bank had already revealed its biggest losses – the bad news was behind it. Well, that was at the beginning of this year. Nine months or so on, it appears that Mr Thain’s comment, if applied to the bank today, is right in this one respect: the bank’s bad news may at last be behind it for the simple reason that Merrill Lynch may no longer exist as an entity for much longer. Last night it was revealed that Bank of America is buying Merrill Lynch, lock, stock and barrel.

Not so long ago, the Fed was the place of last resort for a bank needing money. Last night it was announced that the Fed is to take shares from banks as security for loans.

Not so long ago, Lehman Brothers assured us all was well, and that it had plenty of capital. Last night it went bust.

The last few hours have been so dramatic that Alan Greenspan told ABC that the events unravelling were ”in the process of outstripping anything” he had seen.” He then went on to describe the crisis as a once in a century event.

Not very long ago at all, Alistair Darling talked about the worst conditions in 60 years, and he was lambasted for his words. This morning, Darling’s comments seem to have the ring of remarkable prescience about them.

It seems an odds on cert that shares will tumble today. It must also leave any sensible person questioning the euphoria of last week, when shares soared on the decisions by the US Treasury to nationalise Fannie Mae and Freddie Mac, and in the process almost doubling the size of the US net debt. It is not that the US government didn’t do the right thing with Freddie and Fannie, it is just that it was truly alarming that the right thing was such drastic action.

Talk that we have seen the worst of the credit crunch now seems naive.

Mr Greenspan said yesterday that he thought the finance crisis of 2008 will “continue to be a corrosive force until the price of homes in the United States stabilizes.” Inventory levels of US homes for sale are such that it seems pretty certain US house prices will fall for another year.

Yet, in saying the end of falling US house prices is the key, Mr Greenspan is probably wrong. Once US house prices hit bottom, they won’t shoot up. The housing market is not like a heavy weight at the end of elastic – neither is it like a bungee jump. When prices hit bottom, they will stay there for some time, and those with negative equity will suffer. The ability of home owners to borrow will therefore continue to be impaired, and the massive levels of debt held by US citizens, and indeed by citizens in the UK, will continue to weigh the economy down.

Salvation comes in two forms. The depth of this crisis will lead to falling prices. It has been predicted here that oil will fall to $70 by 2010. We would like to change that prediction; it will fall to $50 in 2010. Food will crash in price too. Cheaper house prices will encourage a new generation of would be first time buyers to enter the housing market, eventually. When these three things happen, that’s cheaper oil, cheaper food and cheaper house prices, the economic fight back will begin.

The speed with which events are unravelling is truly terrifying, and no one predicted it would happen this fast. But the faster the collapse occurs, the sooner we can begin the recovery. Japan’s lost decade was so nasty because it took too long for banks to fail, and for the government to recognize how serious things were. With Alistair Darling very much in the vanguard, Western policy makers know exactly how serious things are. The result won’t be a lost decade – maybe instead we will see a lost couple of years. 2009 will be nasty. No doubt so will 2010. But the recovery, when it happens, will be dramatic too.

The crisis of 2008 is also essential for dealing with the impending pension crisis. The debt build up, occurring at a time when the demographic timebomb was ticking, was very dangerous indeed. The economic recovery will be characterised by a much higher savings rate, sustainable spending on food and energy, and growth based on changes in productivity.

History does not repeat itself. As Mark Twain argued, it is possible it ‘rhymes’. One in a hundred year events don‘t happen, because events just don’t repeat themselves. The current crisis is not a one in a hundred years event, it is unique.

The failure of Lehman Brothers is not a 150-year event, because that is not how old the bank is. In fact, the bank currently known as Lehman Brothers was founded in 1994 when American Express gave up its plan to build up a financial supermarket and spun off a firm which it called Lehman Brothers – only the name was 150 years old.

5.8 per cent of people who have ever lived are alive today. If history is a function of people, then this means history is truncated. Presumably all people alive today will see, during the course of their lifetime, a level of history equivalent to 5.8 per cent of all history that has ever occurred.

Change is changing at an ever-accelerating rate. There is no precedent for the events that are occurring today, but in this Internet age, expect dramatic events with the economy, be they negative or positive, to occur a lot more frequently.

PS – it may be time to stop referring to the current crisis as a credit crunch. When banks fail, it’s solvency crisis. It is not that there is a crunch on credit, it is that there is far too much credit about.

September 10, 2008 | posted by Michael Baxter in Banking | comments (0) |

Here we go again. It is difficult not to be cynical when traders, investors and speculators go out on their shopping spree and push up share prices for rather spurious reasons. And this cynicism has been justified time and time again, as they come tumbling back down again. Yesterday was one of those days. The Dow Jones Industrial Average fell by 280 points, or 2.4 per cent; the S&P 500 fell by even more – 3.4 per cent. The Dow’s fall wasn’t quite as large as the gains seen on the previous day, when it jumped by 290 points, but even so, once again the index is tottering within 200 points of the year low.

The latest reason for the selling: well, once again, a US bank is in trouble, or at least that’s what the rumours say.

Lehman Brothers is no stranger to rumour, nor for that matter is it unusual for the bank to flirt with collapse. It came close to ruin in 1929, 1973, 1984 and 1994. The bank’s troubled history became a troubled present this year. Yesterday’s sell off represented the third time this year that rumours circulated about the stability of the bank.

It is hardly surprising Lehman has problems. Its business model is similar to the model adopted by Bear Stearns, and it was formerly the biggest underwriter of US mortgages. The share price is now down 88 per cent this year, but still its hope comes in the form of its boss Richard Fuld, who has been doing a passing impression of Houdini all year, pulling off escape act, after escape act for the bank.

Back in March, investors had all but given up on the bank, when it revealed its quarterly results – and they were better than expected. Then in April, doubts resurfaced as the bank sought to raise money, but, asked the markets, would it be successful. Well yes it was, in fact so popular was its fund raising, and so willing were investors to pump in more money, that it only decided to go for an injection of $4bn, rather than the original $3bn originally stated.

Yet the talk wouldn’t go away, and June saw the rumour mill grind out more fears on the security of the bank.

Yesterday, it was all back on again and this time there seemed to be both reason for the fears, and hope they would be proved unfounded.

Reason for panic comes in the form of the decision by the Korea Development Bank. Apparently the bank has decided not to pump in $6bn into Lehman after all. By all accounts Lehman really wanted the money – in fact it was giving up a 25 per cent stake for the money. Now you don’t give up 25 per cent stakes unless you are approaching desperation.

Yet the other banks still seem happy to deal with Lehman.

The solution to the latest set of results: the bank is to reveal its latest quarterly results, and the presentation of its strategic review, today rather than next week as originally planned. It is just essential for investors to be impressed.

Mr Fuld has been with the bank since he left college – that was in 1969 – and has worked his way up the hierarchy. Last year he earned $40mn on record earnings. But he has magnanimously agreed to forgo a bonus this year.

It has been said that the banking cycle is around 30 years in length, because that’s just about the length of a typical banker’s career. The current crop of bankers are too young to remember the last time their exuberance led to disaster, so they repeat the mistakes of the previous generation. Well, Mr Fuld may have managed himself a reputation for getting the company off the hook, he may also be the longest serving boss of a major US bank, but he was on the scene during the bank’s three previous crises, so, frankly, the 30-year argument does not apply to him.

August 18, 2008 | posted by Michael Baxter in Banking | comments (1) |

Failure surely is the price we pay for our errors. If we don’t pay a price, then what incentive do we have not to repeat those errors?

Now former Fed chairman Alan Grenspan has entered the debate.

Mr Greenspan told a US newspaper that the Fed and the Treasury “should have wiped out the shareholders, nationalised the institutions with legislation that they are to be reconstituted as five or 10 individual privately-held units,” which would eventually be sold off.

It is a tad ironic. While at the Fed Mr Greenspan didn’t actually do the bail out, but he did orchestrate a rescue of Long Term Capital Management, so that the hedge fund that messed up so spectacularly never actually went bankrupt.

Maybe it was because US banks never actually suffered sufficiently for their recklessness in the mid 1990s, that they went on to repeat the same mistakes this decade.

But at least Northern Rock did actually fail in the end. The UK government did receive all kinds of flak for the Northern Rock debacle, but surely some kind of bail out, preserving the bank, would have sent an awful message to the other banks.

History tells us that the failure of banks can have a catastrophic effect upon the economy.

The economic depression in the US of the 1930s was partly the result of mass banking failure. More recently, Sweden, for example, suffered a major banking crisis in 1991 – and the cost to the economy – 6 per cent of GDP; further back in 1987 it was Norway that was struck, and the cost – 8 per cent of GDP. But in 1997, it was Spain which felt the horror of a full-scale banking crisis – and the cost, 16 per cent of GDP. Examples of other major banking crises include France (1994), Germany (1977), Japan (1992), the US (1984), but top of the order comes the UK (1974, 1991 and 1995). (data supplied by NIESR 2008.)

But things go in circles. Bank failure has in the past caused economic crisis. Maybe, this time around, not enough banking failure has caused this crisis.