Last Throw Of The (Bank) Dice?

19 January 2009 - Last throw of the (bank) dice?

The cogitations of the UK central bank officials over the past weekend has produced more proposed actions aimed at getting the credit lines flowing again. Taken as a whole, are these the last throw of the dice. Or, is there a nationalisation double six still needed to finish the game? The new actions can be summarised as follows:-

1. Banks will be offered a Government guarantee on their toxic debt (it looks like an alternative to the much heralded "bad bank" idea). This insurance scheme will, for a fee, cover losses on toxic assets should they fall below a prescribed level. The bank can pay for the premiums in either cash or shares (we could call the latter option a "taxpayer creep")

2. The £10.5bn of preference shares held by the Government in RBS and Lloyds can be converted into ordinary shares. The upside to this is eradication of the penal coupon on the preference shares and a boost to the bank’s capital ratio. The downside is more taxpayer creep, indeed, it might result in the Government having a majority holding in Lloyds (that now formally owns HBOS) as well as RBS.

3. The Government will offer a guarantee on new mortgages

4. Individual banks will be able to swap new loans for Government securities. Effectively this will extend the Special Liquidity Scheme as described in earlier entries in this diary.

All this weekend’s work was aimed at stabilizing the market upon opening this morning (one assumes). In early trading, RBS, Lloyds and Barclays all fell heavily with the latter having to put out a statement of "know of no reasons etc". Only HSBC held steady.

Some super mathematician has calculated that the combined cost of bailing out banks so far by the US, UK, Europe, China and Japan is $3,000bn. This amounts to 2% of global GDP.

But, we can end with some good news. LIBOR lending rates in the US, UK and in Europe have fallen sharply. US mortgage rates have dropped from 6.5% to 4.88% since this diary started in October 08 and finally companies are issuing bonds again

The diary is now taking a break to see how things look from outside the UK. Back in February.

Working The Weekend

17 January 2009 - Working the weekend 

UK Treasury officials and, more importantly, their myriad advisers are likely to be working all this weekend to find some sort of answer for when the markets re-open on Monday. An answer to stopping the shares of the high street banks falling even further than they did on Friday (yesterday). It is beginning to look more and more as if a so-called "bad bank" will be announced. If such a being is created it would be akin to the toxic fund idea referred to in yesterday’s diary entry and be close to the model adopted by Sweden in the early 1990’s. A new government owned institution would purge the high street banks of their bad loan assets. The idea is to restore confidence to those investors who provide the wholesale funding and encourage private capital back into the banking shares. Something drastic has to be done if only to stop the un-banned "shorters" from having a field day. The extreme example of last week’s bloodbath was our old friend Barclays whose shares fell 40%. It makes one wonder how comfortable those Middle-Easterners are.

From bad to good. In what would be a complete reversal of role, it is rumoured that the state owned Northern Rock might be trained to be the good boy on the block by lending where others fear to tread. In its formative days, this bank was in fear of EU rules on state aid and had to consciously limit what it lent out and also was tasked with paying back as much as possible of the £27bn received from the taxpayer. It would be a case of "look you lot who won’t lend, we have our own bank and will do it for you" sort of thing.

However one looks at it, state control of the entire banking sector is taking a step closer.

That US $700bn Toxic Fund

16 January 2009 - That US $700bn toxic fund

The diary entry of 13th November 08 referred back to an article on this website written before the diary itself started in early October 08. It concerned the setting up of a so-called toxic fund to buy up bad assets and place them in a sort of bad bank (that could be destined for the UK too in the near future). Only now is the US Senate voting on whether to release the second tranche of this fund amounting to $350bn. Like the first instalment, it is not likely to go directly to banks but preferentially to things like the stalled housing market. If the funds are released (that is, created out of thin air) and wherever it goes, it begs the question of how are the big US banks actually fairing. The answer is very badly. Yesterday the shares of both Citigroup and Bank of America fell by 25% and between them these two big banks have absorbed $70bn of US government funds in capital injections. Citigroup is expected to announce a loss of about $10bn for its fourth quarter. There are rumours that it will have to be nationalised within days.

Back in Europe, the central bank has cut interest rates by a further one-half % point to stand at 2% and has resorted to what has been called "stealth easing" in an effort to shore up Europe’s credit system. It has done this by letting its overnight rate drop to 1%, an all time low. Many commentators feel that the ECB has fallen way behind in the action stakes and not fully recognised that, for example, the largest economy in its zone, that of Germany, is likely to have shrunk at an annual rate of 8% in the final quarter of 2008.

Meantime, the issuance of corporate bonds by big blue chip UK companies is at a high ebb as these big businesses build their balance sheets whilst banks continue their reluctance to lend. To attract Joe public the coupon is typically 8% to 9%, a far cry from bank deposit rates

The answer to yesterday’s poser is Ireland.

The Package Arrives

15 January 2009 - The package arrives

After much pondering by the authorities and speculation by the commentators, it has finally arrived. A package of measures announced by the UK Government is intended as the next dose of stimulus to get the juices flowing (regular readers might contrast the approach with that of Germany per yesterday’s diary entry). Three separate initiatives have been announced. First, a Working Capital Scheme. This is a £10bn two year guarantee fund that will secure 50% of the value of £20bn of short term bank loans to businesses with sales of up to £500m. The objective is to encourage banks to hold existing overdraft facilities and extend them. Secondly, an Enterprise Finance Guarantee. This is worth £1.3bn and is a one year fund that will guarantee 75% of risky bank loans to businesses with sales of up to £25m. It is an extended and cheaper version of the existing Small Firms Loan Guarantee Scheme. A premium of 1.5% over commercial rates will apply. Individual businesses will be able to apply for up to £1m and do so on three-month terms to tackle cash flow problems. Thirdly, a Capital For Enterprise Fund. This lowest fund is worth £75m to take stakes in businesses seen as strategically important to the economy but with too much debt on their balance sheet. Somebody unkindly said he could not see the wood for the trees.

About five minutes ago, there was an economy in Western Europe often referred to as either the equivalent Californian Golden Valley, or emerging Asian Tiger. Now its unemployment rate is forecast to end 2009 at 12%, it has a currency that has risen 29% against the pound (ouch) and house prices in its principal city have fallen by 28% in two years. It was the honey trap for all aspiring software engineers and stag-night revellers. Where are we talking about? Answer will be in tomorrow’s diary.

The German Way

14th January 2009 - The German way

Originally this diary referred to the approach of the German state to the credit crunch crisis as maverick in that it refused to tow the fiscal stimulus line set by the US and the UK. Then, as exports were hit with the consequential drag on GDP, a recant was evident as Germany appeared about to follow-my-leader. Looking more closely at what is actually being done shows a different and more cautious approach. The German proposals have been costed at 50bn euros over two years but is founded on a tight fiscal track record and a huge trade surplus. The final outcome could be a deficit of 2% of GDP compared to more like 8% in the US and the UK. The actions include tax and health insurance reductions, more infrastructure spending, a 2,500 euros incentive to encourage people to trade in old vehicles for new low-emissions models and a payment of 100 euros per child. It seems the Germans believe in carrots.

Meanwhile, the UK trade deficit widened to £8.3bn in November 08, the highest level since records began in 1697. In theory, exports were supposed to pick-up with the fall in the relative value of the pound. Instead they fell by 6% mainly due to lower sales to non European Union countries.

But there is always a silver lining. The French and the Belgians are arriving in London in droves with their powerful euros to sweep up our cheap goods and best of all, the Eurostar has never had it so good.

Of Job Losses

13 January 2009 - Of job losses

Thus far in this diary, losses in the UK job market have been ignored. Not because they do not matter, nor because they are not related directly to the credit crunch crisis. Rather because, like businesses going under, a list once started ought in all fairness to be continued and also since such a catalogue is so depressing to compile and read. Nevertheless, things are getting so bad now that the subject cannot be ignored. Yesterday the announcement of jobs lost or under urgent risk can be totalled as nearly 4,000. As worrying as the bald statistic is that they now reach out way beyond the financial and retail sectors. In order of magnitude of the number of jobs reported as going or very likely to go were:-

Land of Leather           (retail of sofas)

Wincanton                   (logistics ie trucks)

JCB                              (diggers)

Findus                          (fish fingers)

Waterford Wedgwood (tableware)

Waterstone’s                (bookseller)

deVries Honda             (car sales)

Christie’s                      (auction house)

Pearson                         (publisher)

And all this in just one day. A day in which, by the way, the Government said there were "10,000 new vacancies every working day". Of course to get them you will need a passport to cloud cuckoo land.

It is worth noting that rather less than 0.5% of new shares in HBOS and Lloyds/TSB were taken up by the ordinary shareholders and so we, the taxpayer, now own 43% of the new megalith.

The rain in Spain falls mainly on the plain. Actually it’s falling all over Spain. The unemployment level is 13.4% or three million people out of work. Spain needs to raise 70bn euros on the bond markets (see yesterday’s diary) and is heavily dependent on the new housing and tourist market. Anyone who has been on holiday lately in the eurozone will understand the significance of this dependency.

My Name Is Bond

12 January 2009 - My name is bond

According to Ambrose Evans-Pritchard of the Daily Telegraph the bond boom that fed the economic appetite for the past five years is going into reverse. This is because treasury bonds are now very expensive with a consequent drop in yields. 10 year US Treasuries have fallen to 2.4%, a level not seen even in the great depression. Yields in Japan are down to 1.3%, 3.0% in Germany, 3.1% in Britain, 3.3% in Chile, and 3.5% in France. The best place to be currently is Brazil at 5.6%. In such a scenario, why would the likes of China, Japan and the oil rich nations continue to amass foreign reserves? As this diary has noted before, the sovereign funds of these nations are shrinking fast and capital flight is discernible. Since August 2008, Russia has lost 27% of its reserves and China has lost $15bn. Japan is in trade deficit. All of this means, according to the article, that the US and European governments cannot rely on others to plug the big hole in their deficits, indeed, Asians are just as likely to be net sellers of bonds.

The principal dilemma is that quantitative easing has started, not least in the US. This could well mean that Mr Bond is less in demand. Bond investors beware.

Would You Believe It?

11 January 2009 - Would you believe it

On the back of those doing as they are told and carrying on spending in the high street and on-line, there is (would you believe it) some good news post the new year season. The winners it seems were those flogging sports leisure goods, cameras, fragrances and the ever faithful John Lewis punters plus a leading retailer of women’s fashion items and electrical goods such as MP3 players and computer consoles. Could it be that the common factor was youthfulness? Best not get too carried away.

Here is something else that is equally hard to believe. It is now 11 months since Northern Rock was nationalised. During that time, the chief financial officer has been grossing (the reports say "earning") £75,000 per month, the executive chairman £90,000 per month and since October 08 the new chief executive is being paid at the rate of £1.1m pa plus a bonus for his first three years. During this nursery stage, thousands of jobs have been axed, the loan book has been drastically shrunk and efforts made to stem the flow of deposits into the new safe haven with the best interest deals in town. Erstwhile shareholders are in court challenging the, meagre, compensation paid and instead of planning to sell the business back to the private sector, there are rumours that Northern Rock may be put into "run-off" and its customer deposits sold as per Bradford & Bingley. This has all the hallmarks of a successful first year for which the new team had to be well rewarded. Would you believe it.

Down Amongst The Dead Men

10 January 2009 - Down amongst the dead men

The National Institute of Economic and Social Research has estimated that UK GDP fell by 1.5% in the fourth quarter of 2008, and Benjamin Williamson an economist at the Centre for Economics and Business Research said the manufacturing sector was in "free fall" after it was reported that it had incurred the biggest slump in 28 years

The US lost 2.6m jobs in 2008, the most in a single year since 1945. The national unemployment rate now stands at 7.2%. The worst part is that the rate is accelerating as the months pass

In the early days of this diary, much emphasis was placed on the housing market as the area in which most direct remedial action was called for. It is therefore interesting to read that a report by Danny Gabay and Shamik Dhar of Fathom Financial Consulting proposes that the Government buys UK homes on the brink of repossession. At an estimated cost of £50bn over five years this action, it is claimed, would help to prevent a further unravelling of the housing market and avoid the social unrest which accompanies repossession. Their suggested plan is for the homes to be bought at a discount to market prices and then rentrd back to their former owners. At a later date, the Government would have an option of either retaining the property or selling it back to the private sector perhaps with a first option to the former owner. Interesting: some of us are old enough to remember council houses and if you are one such person, you might also remember the big programme to sell them back to the sitting tenant.

How Does It Work?

9th January 2009 - How does it work?

The diary entry of two days ago "Stopping the recession" was about putting more money into the economy by way of the central bank. How actually does this work? The central bank increases the size of individual banks’ accounts at the central bank. These accounts are called "reserves". The mechanic of quantitative easing is that the banks build up excess reserves. If banks swap their securities for part of these reserves, the size of their own balance sheet shrinks and as a counterparty, the balance sheet of the central bank increases. With an improved balance sheet, individual banks will then start lending to end borrowers and so put liquidity into the system. In theory at a later date when things have improved (and cynics might say when rampant inflation has set in), reverse quantitative easing is possible by the central bank selling the excess assets which sucks money out of the economy. In theory.

Germany is beginning to recant. The central government is taking a 25% stake in Commerzbank, the second largest bank in Germany, in return for injecting 18bn euros. In practice this is more than a part-nationalisation of one bank because Commerzbank has itself just taken over its hitherto rival Dresdner. Martin Blessing of Commerzbank said "We are weatherproofing our bank for an economically stormy environment". So that’s ok then.

Meantime, back over the pond, the President-elect is seeking approval from Congress for a stimulus package worth (wait for it) up to $1.2 trillion. This is the first time the word "trillion" has appeared in this diary which must indicate something!

UK Bank Rate Cut Again, Why?

08 January 2009 - UK bank rate cut again, why?

So, as widely predicted, the Bank of England’s MPC cut interest rates today by 0.5% to reach an all-time low of 1.5%. Given what has actually happened since the last cut, it is hard to fathom why. The last cut did not kick start the economy and this further slice seems similarly unlikely to. As has been discussed before, it is obviously not the price of money at issue but rather the availability of it. Also, there has to be a very real danger of rampant inflation in the near future if, as appears likely, the pound weakens further or at any rate does not strengthen again. Imports are sure to put up factory gate prices for the home market. Thirdly, and again as opinioned in this diary before, why reward the spenders and punish the now largely deflated savers? It just makes no sense.

An organisation called Fitch Ratings has warned that Britain’s public debt will explode to almost 70% of GDP by the end of 2010. If this occurs, the UK will be one of the most indebted states in the industrial world. A spokesman said that the danger is that it will become increasingly hard to raise enough funds in the global bond markets to cover bank bail-outs and big budget deficits. There is evidence of this being a more immediate issue than might be thought. Yesterday, Germany failed to sell a full batch of its bonds with investors taking up just two-thirds.

Stopping The Recession

07 January 2009 - Stopping the recession

Two leading economists namely Tim Congdon and Gordon Pepper have jointly written a piece in the Daily Telegraph setting forth a theory on how the current recession can be stopped. If they are right of course it would have enormous favourable significance for the businesses about to fail and the perhaps one-and-a-half million workers in the UK alone likely to lose their jobs before 2009 runs its course. Their thesis therefore merits serious attention. The key is money supply and what this diary has referred to frequently as quantitative easing.

The two economists point out that in the years 1929 to 1933, the quantity of money available in the US fell by 40%. The quoted source is A Monetary History of the United States by Milton Friedman and Anna Schwartz. The virtual halving of bank deposits meant that rich people had too little money in their portfolios and so sold stocks and shares to balance out. These sales, it is claimed, merely altered the distribution of money between different investors. Some sort of balance between non-monetary assets and the reduced amount of money was restored only by a crash in the price of shares, real estate, farmland and so on, with catastrophic impacts on demand and output (sounds familiar?). One lesson is that the growth rate of bank deposits must be moderate and steady. However, since 2006 a large and violent fluctuation in growth has occurred, up 15% in 2007 and down 5% in 2008. Congdon and Pepper claim that this lurch from easy monetary conditions to liquidity squeeze has been an important causal influence on the economic downturn.

The answer is not what is being proposed in the UK, that is new credit to the private sector. Rather it is for the Government itself to borrow from the banks and in so doing increasing the quantity of money in the system. "Civil servants can then write cheques to the Government’s suppliers and add to the quantity of money" The amount suggested is between £50bn and £100bn and in early 2009. This diary has warned of the dangers of printing too much money but maybe the two wise men have got their sums right. The big question is, will it happen for the UK? It is certainly being done elsewhere.

More UK Retailers Hit The Dust

06 January 2009 - More UK retailers hit the dust

The entry for 29th December listed six retailers that had failed as a result of the credit crunch. Now we have more. Perhaps the saddest is Waterford Wedgwood which for 250 years has been making and selling fine china and glassware. Its demise is not solely due to the credit crisis but undoubtedly the consequential change in foreign exchange rates has played a big part. The business had about 40% of its sales invoiced in dollars whilst most of its purchases were in either pounds or euros. A horrible squeeze. Another casualty has been USC, a designer clothing chain and a third, albeit much smaller retailer called Passion for Perfume, has also gone under. This list will grow.

The crisis that this diary was spawned to cover started with unprecedented falls in the share price of erstwhile top high-street banks. One swift reaction was to ban "short-selling", the practice of "borrowing shares" in companies expected to suffer a fall in their share price in the hope of making a quick profit by the time the borrower is contractually required to actually buy the shares. The ban was imposed in September 08 and covered the shares in 32 financial companies. It will cease after January 16th. Disclosure of short selling will continue until at least June 09. The stated reason for withdrawing the ban is that it had little if any effect in either curbing price falls or in reducing share price volatility.

Of Civil Unrest & Public Spending

5th January 09 - Of civil unrest and public spending

A thread that has run through the prophesies for 2009 of the more serious economic commentators has been a muttering about civil unrest. Those nations that have built their financial surpluses from exports are witnessing a return to their rural homeland of workers hitherto pulled to the urban factories for mass production. Compounding this reversal of population flow is the dearth of jobs for the university graduates as turned out by the hundreds of thousands. The dashing of expectation can be a toxic mix and the fulcrum is China not least due to the swiftness of the turnaround. As recently as October 08, China’s exports rose by 17.6% year on year and yet only one month later predictions were for a growth rate of somewhere between 5%-6%. December 08 is likely to see an actual contraction. The scale of this change is massive and it is having a knock-on affect across the whole of the Far East and not least South Korea where exports fell in December by 15%. One can only hope that of all the dire predictions for this new year, any form of civil unrest is not one that materialises.

This diary has commented earlier on maverick Germany in the sense of not toeing, indeed vociferously opposing, the Anglo line on financing the banks. Latest reports seem to indicate that the mood is changing albeit the methodology is different. A package of measures totalling £24bn is close to agreement and the beneficiaries will be infrastructure such as railways and roads. This route is similar to that taken by China, Japan and perhaps soon to be the US under its new President.

Savers To Save Us

4th January 2009 - Savers to save us

If the monetary pump has not been primed to whatever effect, see yesterday’s diary entry, and still not to risk banks going bust ala northern rock, it makes one wonder if there had been some other way out of the blocked credit conundrum. Had there been, it might have prevented what to a majority of people is the very worst consequence, that is, the pummelling of savings rates. As the central bank cut its bank rate and although the wholesale market only followed suit later and reluctantly, so savings were hit hard. So hard in fact that millions of savers are poised to hear they have zero % accounts. So here is a too-late crazy idea. Supposing the savers who are in a ratio of 6:1 to borrowers had had all their savings guaranteed 100% by the government from the start and then this liability sitting in the banks’ books had been pledged by the government. This would have given the banks a gilt-edged asset to match the savings liability and so increased the banks’ reserves. Could this have worked? If it was a possible goer, then savers would be rewarded for their commitment rather than punished as a consequence of the pump priming. As it is, the likelihood is that the likes of RBS and Lloyds/TSB and HBOS will have to receive more funds and indeed may be nationalised completely. Surly it would have been better to have the savers save us?

It is a sad fact that what is left of the UK’s indigenous manufacturing sector is in the worst slump since the early 1990’s. In theory our exporters should be benefiting from the weak pound but two principal factors mitigate against this. First, the receiving market is likewise weak and secondly the imported raw materials are more expensive. If only we had not stuffed our homes with Chinese-made goods, but this is a global world after all - and don’t we all now know it.

It Is Not Working

03 January 2009 - It is not working

The gut anti-reaction, voiced in this diary pretty much from the start, to the plethora of measures to get credit flowing again, is that it will not work. The raising of the Tier 1 safety net for bank reserves that in turn caused banks to take new funds either from shareholders (largely failed) or central government or foreign investors (largely overseas quasi-governments) has had an effect. But it has been the opposite of that intended. If you force banks to take on expensive debt - preference shares with a huge dividend attached - and attack their very independence with also expensive equity stakes, it is just as likely to make them more conscious of the weakness of the balance sheet that started the process. So were they likely to loosen their lending criteria to proper customers alongside ceasing to lend to improper ones? Then there was the idea of making huge loans available, guaranteeing deposits and inter-bank balances and intervening directly into the credit markets. Even quantitative easing, that is, printing money. These latter actions had more chance of success but the effects have been marginal. 

The point is that markets, any markets, are difficult to manipulate. Sometimes, like smoking too much, drinking too much, snorting too much, consequences have to be faced. Why is spending too much any different? Yet right now in the UK we have the ludicrous situation where retailers are being encouraged to discount heavily to get the masses to spend what we know this group haven’t got and weaken the already weak sector even further. If regular readers of this diary have picked up nothing else, then surely it is that today’s cash-flow is no indicator of future survival. Businesses have to be profitable and individual householders have to be profitable. Borrowing to spend is stupidity in the extreme unless that spending itself is profitable.

This is not a lone-voice view. Serious economists and government ministers as far apart as Australia, Sweden and Germany have already expressed their reticence to follow the spend route. Expect more to follow.

Annus Horribilis, UK Stock Market

02 January 2009 - Annus horribilis, UK Stock Market

The index of the top 250 UK shares after the top 100 (see UK Stock Market History on this website), often referred to as second-liners and which are the most representative of the nation as a whole, fell 40.3% during 2008. That was its worst year on record. For investors and savers alike it was an annus horribilis. Part of the explanation for this bigger fall than the big-boys index (down 31% by the end of the last trading day) is that the FTSE 250 has 45% of its constituents in the industrial, consumer services and retail shares. This is a much bigger proportion than in the top companies and serves to show just how far the credit crisis moved from its roots in the investment banking arena. The biggest losers by industrial category were builders and related suppliers, tenanted pub owners and retailers. If there are any smiles around they belong to the insurers, insurance brokers and underwriters and to a lesser extend the utility companies and transportation businesses. One really alarming factor is how the consequences of the credit crunch crisis caught the most seasoned observers on the hop. This diary has yet to find a single commentator or economist who predicted this time last year what was about to happen. Compounding this surprise element is the fact that merger and acquisition activity dried up and it is this business that fuels much of the city professionals’ workload.

Returning to the international scene, Belarus has become the sixth country to be rescued by the IMF. It secured a loan of $2.5bn. Russia has pledged a further $2bn. The fundamental cause has been a run on its foreign reserves. The two keys exports of Belarus are potash fertiliser and oil products both of which have suffered from the severe fall in commodity prices (oil has fallen to $40 a barrel - see earlier entries in this diary discussing how such a low price is likely to stifle investment in new drillings) 

Is there anyone out there predicting the 2009 investment scene?