Bank balance sheets become focus of scrutiny
Heard in London: Hedge fund economist: "Hey Bill I am worried that one of the major banks will go under by next year." Hedge fund manager: "Fred I am certain one of them is going to go under". Now hedge fund people move in a world of febrility, giant risk and hyperbole but this conversation happened, and recently (names changed, obviously).
If it's a plausible risk it explains why much of Gordon Brown/Alistair Darling's effort on the economic front was focused on patching up bank regulation and boosting liquidity. Far from "shutting the stable door after the Northern Rock has bolted", there may yet be the danger of another, more thoroughbred, horse kicking the stable door down and careering between Canary Wharf and Poultry smashing things up at all points in-between. We'll be looking at this on Newsnight sometime this week but, for now, here's a primer on what they're worried about...
1) The UK banking sector's shares have been hammered badly, causing them to go cap in hand to their existing shareholders for more capital. HBOS, plummeting today, is at £2.95 a share as I write and was £10 a share this time last year. The sector has lost around 70% of its mid-2007 value. In French they have the "mot de Cambronne"; in English we must reach for the "mot de Mottram" to describe such situations. (See for an explanation).
2) They've been taken by surprise. Six months ago many bank bosses were insisting they did not need to go to the markets for more money; but now, through "rights issues", they have collectively raised about 21bn GBP. They needed to do this because the "capital adequacy" rules which govern banks say that their capital (represented by the value of their shares) has to be a certain percentage of the risk they are carrying on their books. That is why, this week, financial journalists and analysts will be scrutinising the balance sheets, not the profit and loss statements so much. in the Guardian has more on this.
3) Capital adequacy rules are complex: unlike a straight "debt-to-equity" percentage, such as you use with your mortgage (say you have a 95k mortgage on a 100k house then you have 5% equity), the theory of capital adequacy allows banks and regulators to "weight" various types of debt according to risk. Right now the Basel II international regulation regime is because existing models are "not capturing" huge swings in the scale of risk. And the risks are increasing...
4) Soon UK banks could begin to be exposed to problems in the UK mortgage market: the subprime crisis began in the US of course, triggering a freeze-up of inter-bank lending across the globe. If UK house prices fall 20%, says Sandy Chen at Panmure Gordon, then of the 1.2 trillion UK mortgage lending, there would be 360bn of mortgages in negative equity, affecting 3 million households (Research note: 13.05.08) . That risk must be reflected in the balance sheets of the banks and demand, at some point, a return to the stock markets to raise more capital to meet the adequacy requirements.
5) But all is not well in the world of rights issues. The HBOS rights issue has been politely described by commentators as "a disaster". Only 8% of small investors decided it was worth buying the shares. The underwriters were initially left with 2.5bn of unsold shares, a position which they then had to do some nifty financial footwork to ameliorate. It is that the FSA is looking at new rules to speed up rights issues and prevent potential market manipulation; however this does not address the worst-case scenario that finance boffins are worried about: that at some point there will be a bank that HAS to raise capital but CANNOT raise capital on the markets. Cue a string of cutprice takeovers (a breakup bid for HBOS is being reported today by the Telegraph; Alliance and Leicester is the subject of a takeover bid by Santander at a price of £3.18 per share (currently trading at £3.39, price just over £10 one year ago).
If it comes to pass that an ailing bank cannot be taken over, then that is where Sir Richard Mottram's famous phrase will become appropriate. That is what I think hedge fund people are worried about when they ruminate about a banking collapse - and of course the really frightening thing is that there will be people out there who believe they can make money out of it, just as they make money pushing the price of grain or oil higher.
If you read the briefings coming out of government during this weekend of crisis/backstabbing you can see this linked problem of the mortgage market and the banking system is high on their agenda: someone has been briefing that they are to launch a US-style bailout system for the mortgage market where the government effectively becomes the guarantor of new mortgage lending; and a stronger depositor insurance scheme looks likely to be rushed in.
If all this makes you nervous, at least we know now - after Northern Rock, Fannie Mae, Indy Mac and Bear Stearns - what happens when a bank fails: its depositors get bailed out by the government and its shareholders don't. No pattern has yet been established about the bailout of investment banks and other hybrid institutions though (with Bear Stearns the USA had to bend its own rules).
A final note on all this: I am not a banking analyst and I can only go off what the experts tell me, and to report what I hear. I am not saying there's going to be a banking collapse and I have no inside knowledge. There are many checks and balances in the system and the regulators are patrolling like Bondi lifesavers at shark feeding time. Do not take any decisions on the basis of what I write: it's only meant to aid understanding of the financial, regulatory and political news as it develops. If you think different or know better, please hit the comment button and set me straight!
Comment number 1.
At 28th Jul 2008, madmarshman wrote:How does all this fit in with today's trumpted announcement that house prices will be 25% up in five years after reducing by just 2% next year?
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Comment number 2.
At 28th Jul 2008, Nick Drew wrote:The rights issue model for raising capital has - perhaps fatally, in the short term - in recent days by the HBOS fiasco
and there aren't many more Santander-style White Knights
which leaves us with (a) taxes and (b) Sovereign Wealth ... not a comfortable choice.
Who'd be PM, or Chancellor, eh ?
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Comment number 3.
At 28th Jul 2008, BorisAhoy wrote:What I have been trying to understand for the last few months is where all the value has gone. Even if some real value is being destroyed it can't be that much so where has it all gone ?
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Comment number 4.
At 28th Jul 2008, shiveringphilmk wrote:"1) The UK banking sector's shares have been hammered badly, causing them to go cap in hand to their existing shareholders for more capital."
No - share price movement does not increase or reduce the amount of capital a bank has but rather its market capitalisation. When a company issues shares it receives the price issued at, the movement after this is not the concern of the company but the shareholders. Companies should be concerned with their shareprice but not because this changes their capital but rather to keep the shareholders happy.
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Comment number 5.
At 28th Jul 2008, dthomson69 wrote:This crisis has similar issues to that in pensions 5 years ago. The Government sets rules on solvency. Then something unexpected happens. The rules bankrupt some unfortunate people before someone realises we will all go bankrupt at this rate, and then the rules are re-written.
I've no confidence that the new solvency rules (as for pensions solvency rules) will be any more relevant in 10 years time than the old ones are now. That isn't to say they won't be strong enough, just not relevant. The one thing I know for sure is, something unexpected will happen!
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Comment number 6.
At 28th Jul 2008, bookhimdano wrote:its a mixed picture. not every uk high st bank has sub prime debt [if you want to know who they are think of ones no one mentions] and they are fine.
the western banking model is made up of necessary fictions. Fractional reserve is a fiction based upon human behaviour. It only fails when humans do not behave as expected [e.g everyone taking out their money at the same time]. As fiat banking is a behaviour [no gold standard etc] how do you massage human behaviour? With propaganda. With illusions. So bankers need to be great actors.
Many years ago I remember watching 'steady' Eddie George reporting to parliament and he gave a 'performance' of being a financial wizard. With subtle slow hand gestures and a slow delivery that delivered confidence.
Govt thought when they sold off their retail banking arm that was the end of it but such is banking that the govt will always need a retail banking arm run on sound finance. In the event its picked up northern rock. It might pick up some more. The belief in the market as the only most efficient agent is the model that has failed.
That model is failing in energy too as the uk customer is charged more than anyone in the eu [who have regulated markets]. Markets are proving again and again they are there to deliver profit not social services.
Meanwhile as the famous saying goes the time to buy is when there are riots in the streets.
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Comment number 7.
At 28th Jul 2008, treloarbiker wrote:Banks or Bookmakers?
How have US banks managed to 'lay off' a great chunk of their subprime mortgage bets to UK banks?
Buying the debt at a much reduced rate must have at the time seen to be a 'no brainer' to greedy fund managers and executive shareholders.
Even if the debt were purchased at 10 cents on the $ the loans were given to people with no visable means of support other than a state handout. US banks knew they were never going to recover their money.
Stupid and greedy bank executives have been betting with our money and now we have to pay for it.
Can we bring back publoic flogging for bank CEO's?
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Comment number 8.
At 28th Jul 2008, therealhotairmail wrote:I don't think anyone knows what they are doing.
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Comment number 9.
At 28th Jul 2008, threnodio wrote:#8 - therealhotairmail
On the contrary, they all know what they are doing - but it is not their money is it? It's yours.
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Comment number 10.
At 28th Jul 2008, SheffTim wrote:What I find truly disturbing is that no one seems to be legally culpable. I imagine the sub prime business wasn`t the only catalyst behind all this; but someone dreamt up the sub prime business, people decided to invest in it and so on. Yet it appears no one can be taken to trial, none of these that earnt large bonuses will be financially penalised, no one is held accountable.
It appears the finance houses are beyond the law and above government reach, regardless of how much harm they do.
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Comment number 11.
At 28th Jul 2008, elmiperru wrote:This comment was removed because the moderators found it broke the house rules. Explain.
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Comment number 12.
At 28th Jul 2008, Andy wrote:I am not sure that there is anthing new here, the banks have mis-managed their business, the regulators have not regulated and the government have not governed. We all knew that.
Why Paul Mason should decide to dig this up at this point I am not sure, either he has just noticed or he has nothing better to write.
Will a big bank go under - I think we would all be surprised if it did, given the focus on this sector, without the BoE having a rescue plan. If any Bank has bad news then they have had adequate opportunity to share it. The banks have a pretty good idea of what other banks are up to, they should know were the problems are.
The negative equity comment is strange, if 25% of UK mortgage lending is to households with less than 20% of equity in their properties then that is a poor reflection on our banks.
On the other hand the negative equity issue is one of affordability, it's not a problem unless the house is sold or the householder can't afford their payments.
On a positive note are the government not just in the middle of making several £billion from their last rescue and Richard Branston had a plan to make £1.5 billion from N.Rock.
There is also a lot of cash about looking for bargins, this will come back into the market soon if prices remain low.
The probability is that life will go an and we will all cheer up in about a year, we will get happier when the US elections are over and come next spring things will strart to look a bit better.
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Comment number 13.
At 28th Jul 2008, deathbymince wrote:I don't know much about the credit crunch, however, I do know that reporting unattributable gossip isn't exactly award winning journalism.
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Comment number 14.
At 28th Jul 2008, hitono wrote:I met a bloke in a pub and he said the same... He was wearing a suit and it was in Canary Wharf... So it must be true.
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Comment number 15.
At 28th Jul 2008, mrpaulbh wrote:iI do work in Financial Services and can assure you no one knows exactly what is going on,but I AGREE WITH DEATHBYMINCE that unattributable gossip is no substitute for good journalism. The more this type of comment gets into the mainstream press the more ordinairy people will believe it and then panic.I suggest next time keep the gossip to yourself and report only what you know you can back up.
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Comment number 16.
At 28th Jul 2008, PaulMasonOfNewsnight wrote:Hi #13, #14, #15 - if this were "reporting" then you would have a point. As it is, it is blogging. It is not meant to be award winning journalism.
And I am not reporting "unsubstantiated gossip" - I am reporting a real conversation between two serious people. I am absolutely sure neither of them *knows* a bank will fail. I am sure one of them is going to be taking investment decisions on the basis of this. Sure, for those in the know, there is nothing new (ie today new) here; however I am trying to piece together what is happening and I now think the UK authorities are right to have put so much emphasis on pre-emptive banking regulation. They see a lot more than any of us.
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Comment number 17.
At 29th Jul 2008, JunkkMale wrote:Not sure I can get my head around this, not just as a possible official insight into national media broadcasting/publishing editorial definitions, but also consistency...:
'...if this were "reporting" then you would have a point. As it is, it is blogging.... I am reporting a...'
So... is it reporting... or blogging, and what then is the difference as it still appears in print, for public consumption, from a Ö÷²¥´óÐã reporter on a Ö÷²¥´óÐã organ of news sharing?
I am to in future ignore all I read on these pages?
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Comment number 18.
At 29th Jul 2008, barriesingleton wrote:IGNORING IS BLISS (#17)
Way to go JunkkMale. Herewith permission to ignore anything of mine. I don't really approve of bloodsports . . .
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Comment number 19.
At 29th Jul 2008, JunkkMale wrote:Barrie,
Consider yourself ig... oh... rats.
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Comment number 20.
At 29th Jul 2008, barriesingleton wrote:PRICELESS JUNKKMALE #19
Nice one. Thanks. It took a moment then the penny dropped - always the best laugh.
On to oblivion . . .
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Comment number 21.
At 29th Jul 2008, PaulMasonOfNewsnight wrote:In on-screen reporting you can pursue bar stool intelligence and try to stand it up as fact. With blogging, I think it's legitimate to explain what people are saying if it's relevant and plausible and doesn't libel anybody, and especially when as "sentiment" it is a material factor in events. If people are beginning to act on an idea it becomes relevant even if not true. I'm trying to help people understand the scale of private concern in the financial sector, is all.
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Comment number 22.
At 30th Jul 2008, JunkkMale wrote:21. At 11:15pm on 29 Jul 2008, PaulMasonOfNewsnight
Errrr... thank you, I think.
Donald. Bill... a little help here!
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Comment number 23.
At 31st Jul 2008, David Evershed wrote:Paul
The fund management performance of hedge fund managers as a whole is worse than that of indexed funds. Note: you need to ensure that any statistics you get about fund manager performance allows for "survivability" ie those that have closed.
Any individual hedge fund manager will have a vested interest in talking up or talking down bank shares, depending upon whether they are long or short at the time.
Better to seek out facts from analysts and draw your own conclusions from the facts than to trust someone else's opinion without knowing the facts and arguments which led them to form their opinion.
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