September 22, 2008 | posted by Michael Baxter in Banking | comments (1) |

Ever since the Glass-Steagall Act of 1933 in the US there have been two types of banks: commercial and investment banks. It is in a way quite ironic, the US government set up a legal framework to keep the two types of banks separate as a part of its efforts to bring the great depression of the 1930s to an end.

Sixty-five years on, and it has been reversed. Last night, the US Treasury Secretary Henry Paulson revealed new rules allowing investment banks to operate as commercial banks too.

In that one move, the former chairman of Goldman Sachs appeared to provide a new hope for the two remaining investment banks in the US, Morgan Stanley and Goldman Sachs.

It means the duo will be able to take deposits from customers, that’s people such as you and me.

It means they will be able to get loans from the Fed. On a temporary basis they were afforded the ability to obtain loans after the collapse of Bear Stearns, but this was just a temporary facility. But, above all, it means the two banks will no longer be reliant on the money markets, now they will be able to secure their funding from the public.

You must spare some sympathy for Lehman Brothers and Merrill Lynch. If the new rules had been enacted sooner, Lehman may have survived and Merrill Lynch retained its independence. But that, in a way, is the point. It took the sad fate of these two banks to create an environment in which the new rules were considered acceptable.

Of course, commercial banks and investment banks have been able to exist under the same umbrella for some time. In 1999, the Gramm-Leach-Bliley Act repealed those provisions of the Glass-Steagall Act from owning other financial companies. In 2000, J.P. Morgan & Co. merged with Chase Manhattan Corp – and last week Merrill Lynch was bought by Bank of America. In the UK, banks do combine their activities with investment banking; consider, for example, Barclays Capital. And of course Barclays itself has bought up Lehman assets.

What is different this time around is that Goldman Sachs and Morgan Stanley will stay independent. Commercial and investment banking will be managed under the one roof.

Capitalism works when it is allowed to facilitate evolution. This morning, with the decision to let the two remaining US investment banks become commercial banks too, we saw evolution in the banking sector.

But evolution does not always work. To illustrate this, evolutionary biologists often cite the example of the male peacock. Its heavy tail weighs the bird down, making it less well adapted to survive. It is just that, or so it is theorized, the female of the species, through a mutation in the gene for determining sexual attractiveness, is rather partial to males with colourful tails. The more males with colourful tails breed with females who find this a turn on, the more the gene for creating colourful tails in males, and for making this attractive in females, is passed on.

Presumably the male peacock will eventually come unstuck.

In making Goldman Sachs and Morgan Stanley able to trade as commercial banks, let’s hope the US government has not created the wrong type of adaptation – and that the two banks won’t strut their feathers like peacocks, making the same old mistakes, all over again.

September 17, 2008 | posted by Michael Baxter in Banking | comments (0) |

And then there were two. There’s just two investment banks left Stateside now; how long will even they last?

Yesterday the dynamic duo both revealed their latest results.

Profits at Goldman Sachs crashed – but the bank still made a profit. A year ago, net income came in at $2.85bn, in the quarter just gone it was just $845mn.

Profits at Morgan Stanley were down by a mere 8 per cent on a year ago, to $1.43bn.

It is odd how there seems to be such growing conviction that the two banks are living in numbered days, that sooner or later they will be bought, when they are both so profitable.

Colm Kelleher, Morgan Stanley’s chief financial office said: “It is very important to get some sanity back into the market.” In fact, so keen were the bank to get this sanity back, they announced their results a day early.

The snag is, those in the asylum are not listening.

When bubbles crash, there is always an overreaction. Right now Goldman Sachs and Morgan Stanley are trying to stop a tide, and when that tide is made of irrational panic, there is little one can do to stop it.

July 22, 2008 | posted by Michael Baxter in Banking | comments (0) |

If you want to know why we have booms and busts then you can do a lot worse than look at that familiar ape -like creature called us. We overreact. When markets boom we jump on, and a kind of mass exuberance exaggerates the boom. When markets tumble, we go the other way.

In his book, Age of Turbulence, Alan Greenspan put it this way: “History is replete with waves of self-reinforcing enthusiasm and despair, innate human characteristics not subject to learning curves.”

Sometimes people emerge with sufficient vision to spot the madness for what it is. Joe Kennedy, father of the late president, famously sold his stock on the eve of the 1929 crash after a cab driver asked for his advice on what stocks to buy. In doing that he proved his shrewd mind.

Sir Isaac Newton was not so astute. He may have been one of the cleverest men ever to have come out of Britain, but he forgot his own laws, and lost a fortune as a result.

When the South Sea Bubble was in full swing, Sir Isaac had one of his sitting under the apple tree moments. “This market has risen too high, it’s bound to fall,” he reasoned. So he sold out. Then he had a change of heart, bought back just before the market imploded. He lost £20,000, a fortune for those days, and is reported to have said, “I can calculate the motions of heavenly bodies, but not the madness of people.”

Yet sometimes the madmen can prove to be quite wise.

When shares in Northern Rock tumbled, many thought they saw a buying opportunity and leapt back in. But, as you know, things just got worse. It was a similar story with Bear Stearns, and more recently it happened with the collapsed US bank IndyMac. Sometimes a seemingly mad sell off can be based on good logic.

So judging madness from intuition can be quite difficult. Which just goes to show it is probably impossible to call top and bottom. And it is impossible to judge investment decisions right each time, but the key lies in being broadly right. Buy when it appears markets have hit bottom, and if they carry on falling, well, in a few years’ time your decision will still probably look quite clever.

So, have bank stocks been oversold?

One would have thought that Dresdner Kleinwort and Morgan Stanley were switched on to be able to identify true value. Presumably they had a good reason to underwrite the HBOS rights issue last April; they clearly thought the rights issue share price was as safe as, well, as safe as houses.

Yet, in the three months or so that followed, the share price halved, and the two underwriters were left nursing their commitment. Did they mess up? Or are they left holding shares that may prove to be very valuable in a couple of years’ time? After all, with another £4bn in the coffers, one assumes HBOS is well placed to exploit the opportunity that is opening up.

As for Barclays, its efforts to raise money at a time of such troubles left overseas investors thinking they had spotted an opportunity. And now the Qatar Investment Authority has a 6 per cent stake in the bank, another Qatari investment vehicle a further 2 per cent stake and the Japanese bank Sumitomo Mitsui a 2.1 per cent shareholding.

For years Britain was on the receiving end of cheap credit from abroad. Cheap credit that helped fund a massive deficit in our current account. But now it is a different story. Britain is going cheap. In the longer term this may well lead to big dividend flows out of Britain that could lead to structural weakness in the pound.

But maybe we should look to private equity for a hint as to how close we are to bottom.

Recently, TPG couldn’t get away from Bradford and Bingley’s fund-raising efforts fast enough. But according to this morning’s FT, private equity outfit Blackstone is looking to buy buy-to-let mortgage specialist Paragon.

Blackstone had the sense to float on the New York Stock Exchange last year before the credit crunch crisis erupted. It also received a healthy dollop of funds from China too, but this was before the great crash in asset values, so it got a nice price for its stock. So, presumably, it’s got a lot of dough in the coffers.

So there is no shortage of shrewd investors who reckon banking shares have fallen too far. They may well be right, but when madness gets a grip it can take a long time before correct valuations become clear. They may yet have a long wait before banking shares reach anything like the highs seen a year or so ago.

It’s a promising sign that Blackstone has seen potential in a mortgage lender, but don’t expect this to represent the end of the financial shocks. When markets are correcting it can take a long time before we finally rid ourselves of the need for an asylum.

July 21, 2008 | posted by Michael Baxter in Banking | comments (0) |

Well, shareholders in HBOS, the Bank of England, and maybe just about all of us, need to be grateful for Morgan Stanley and Dresdner.

The bank’s attempt to shore up its balance sheet by raising £4bn has been a disaster. Only 8 per cent or so of shareholders subscribed to the rights issue. It is hardly surprising. Existing shareholders were offered the opportunity to buy two new shares for every five shares they already owned, at a price of 275p. When the rights issue was announced the HBOS share price was around 500p. So it seemed like a good deal at the time.

Morgan Stanley and Dresdner certainly seemed to think it was a good deal, which was why they were willing to underwrite the issue.

But then the share price fell, fell and fell some more, so that today it has been hovering around the rights issue price all day.

The two underwriters are trying to offload the shares – but this creates the danger that a share price crash could be precipitated.

HBOS went to lengths to point out it has raised the money. So we don’t need to worry. Well, maybe we don’t for now. But, presumably, all this will blow a hole in Morgan Stanley and Dresdner’s balance sheets, which they may need to eventually plug via their own fund-raising efforts.

But the big worry must surely relate to what happens if HBOS needs to go out and raise some more. And for that matter, it is leaving all banks who are hoping to raise some readies looking vulnerable.

June 12, 2008 | posted by Michael Baxter in Banking | comments (0) |

But then again, things are not much better for HBOS, and for that matter Morgan Stanley and Dresdner Kleinwort must be somewhat irked.

If you can call being forced to stump up £4bn being irked, that is.

The investment bank duo agreed to underwrite the HBOS rights issue at 275p a share. That was back in April – a month which saw the bank’s share price fluctuate between 600 and around 480p.

At the time of writing, the HBOS share price is just 263p.

It is difficult to imagine why anyone would support a rights issue for a price which is higher than the trading price. 

This leaves just three options. Option 1, force Morgan Stanley and Dresdner Kleinwort to buy all the shares they underwrote.  They did, after all, get a nice fat fee for underwriting it.

Option 2, change the rights issue – reduce the price – but by how much will they have to reduce it?

Option 3 – go to an outside investor – but again, at what price?

Yesterday, the bank put out a terse statement saying: “Current trading and specifically mortgage-arrears performance was in line with the Group’s expectations.”

Maybe, but we are sure share trading isn’t in line with expectations.

As was said above while discussing Barratt, investors’ appetite for supporting rights issues must be waning.    The continual fall in banking shares must make this appetite even more satiated.