The Great Pension Divide

31st March 09 - The great pension divide

The management consultancy review with my director boss wasn’t going so well and I was stung into saying "but Henry, that is just not fair". He looked straight at me through big droopy eyes, took a great intake of breath and said in an exasperated tone "John - life isn’t fair". I do not suppose for one second that when all these good people entered public sector employment they thought they had pulled a fast one. I feel sure that a final salary defined benefit pension scheme was not the number one determinant in becoming a county council planning officer or even a police officer. Nevertheless, these one-in-five UK job holders are increasingly seen as privileged and not only because their numbers continue to increase as general unemployment passes two million on its way to three and a half million and pay increases continue whilst all the rest take cuts. No, the main gripe is the pensions divide and as more and more are forced to accept defined contribution pension schemes with investment returns negative in real terms, so the gripe will deepen. It is no exaggeration to say that social unrest in bubbling.

John Ralfe, an independent pensions consultant and who used to be the head of corporate finance at Boots the chemist, has analysed the published accounts of 55 of the 81English local authorities which account for 90% of the Local Government Pension Scheme (LGPS) assets in England. He points out that actuarial estimates tend to assume better investment returns than those used under FRS17, the measure commonly adopted by private pension schemes. Using FRS17 methodology, he produced a deficit of £42bn on LGPS as at 31st March 07 and for England alone. This has, according to him, ballooned to £80bn by February 09. Adding to this the position of Scotland, Wales and Northern Ireland brings the deficit to £100bn.

Mr Ralfe said "Neither individual local authorities, nor central government, recognise the real nature of the LGPS deficit, and thus have no plan to address it, other than keeping their fingers crossed and hoping the massive equity bet will pay off. Meanwhile, the deficit will have to be paid by future taxpayers."

People on the wrong end of jobs, pay and pensions are feeling the divide between the have’s and the have nots. Not healthy.

RBS, So Who Authorised What?

30th March 09 - RBS, so who authorised what?

This diary has tracked the demise of the once mighty Royal Bank of Scotland and its rescue by the taxpayer and how the major blame has fallen on the purchase of HBOS. It is now reported that subsidiaries of RBS in the US were buying up toxic loans and further that this policy was not reported to the main board. In early 2007 it is said that more than £30 billion of sub-prime assets were purchased and resulting in many £millions of bonuses for the traders involved. As a direct result, the bank "didn’t stand a chance" of surviving without the bail out according to one director as reported in the Daily Telegraph. Let us recall that last month RBS posted a loss of £28 billion, a record loss in British corporate history. So how did this gigantean spree occur and who authorised it?

When this diary opened nearly six months ago, all attention was focused on loans made to poorer people in America who, almost by definition, often default on repayment. Such loans were then bundled up, renamed and sold on. It is claimed that Citizens Bank (a subsidiary of RBS in the US) bought up such packages without Board approval. In the foreword to RBS’s 2006 annual report as published in April 2007, the chief executive wrote "Sound control of risk is fundamental to the Group’s business. Central to this is our long-standing aversion to sub-prime lending, wherever we do business". On April 13 2007, New Century Financial, one of US’s sub-prime lenders which was facing bankruptcy, disclosed in a Delaware court that it had agreed to sell 2,000 existing sub-prime mortgages to a unit of RBS called RBS Greenwich Capital Financial Products. At about the same time, another major US sub-prime lender Fremont General Corporation, had a $1billion line of credit extended to it by RBS.

The question arises, do we have a sleight of hand here? RBS did not engage directly in sub-prime issuing. OK. But its US interests bought up such toxic debts in huge swathes and furthermore it inherited more from its acquisition of ABN AMRO, the Dutch banking group. When a medium sized UK bank goes on a global expansion track, can it control what its overseas bits are doing? What are the decision pointers to the main board? Who exactly did what to whom and who authorised it?

US Fed follows Bank of England

27th March 09 - US Fed follows Bank of England

The US Federal Reserve has, for the first time, gone into the business of quantitative easing. Following the recent action of the Bank of England, America’s central bank is to buy $300bn of US government securities, that is to say, it is monetising its own debt or printing dollars. It is its first foray into these, largely unchartered, waters. But this specific action is only part of a new monetary stimulus programme. The Federal Open Markets Committee (FOMC) is to buy up to $750bn of additional agency mortgage-backed securities and to double its debt by adding $100bn. In total this action amounts to $1.15 trillion dollars of spending to get the economy moving again.

The FOMC also made a commitment to keep interest rates in the 0-0.25% range. The immediate reaction of the markets to the extra revenue and interest rate retention was for the Dow Jones Industrial Average to reverse recent declines and for the dollar to lose value against both the euro and the pound. The conclusion statement put out by the FOMC was "Although the near-term economic outlook is weak, the committee anticipates that policy actions to stabilise financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth". Somehow, this massive package of intervention in the money markets added to all those that have gone before, seems out of proportion to the extremely cautious statement from the FOMC. It just shows how no-one really knows what the future holds.

Lord Adair Turner, the relatively new boss of the UK FSA (and, incidentally, a former management consultant) has issued his first review of banking regulation. The main message seems to be that regulations in the UK will have to tighten significantly but that, since such toughening will take place globally, this will not unduly disadvantage the UK as a centre for city business. His findings can be summarised as:-

• Banks will be required to hold more capital

• Given that trading is global, the separation of clearing and merchant banking activities in not feasible

• There is far too much fallout to allow a purely investment bank to fail

• The concentration by a bank on traditional "narrow" banking activities does not necessarily make it less risky

• Excessive risk taking is mostly caused since "dominant executive personalities have a strong tendency to believe in their own strategies"

• Capping mortgages will disadvantage those first-time buyers without wealthy parents to help then and could encourage the use of credit cards or unsecured loans to bridge the gap.

These findings are not populist ones but to me do rank as worthy of a good objective consultant who called the present situation "the greatest crisis in the history of finance capitalism."

Anger At The Micro Level

26th March 09 - Anger at the micro level

This diary has dealt mainly with the effects of the economic crisis at the macro level. The big picture ought not to hide the consequences of decisions taken at individual business level and particularly when they affect directly Mr Joe ordinary bloke. Here are two examples. The Chelsea Building Society (actually based in Cheltenham UK) promotes itself as the fifth largest mutual building society in the UK, which isn’t actually saying a lot since most of the biggys turned themselves into banks. As a "safe haven" investor in the society myself, I was privileged to receive a copy of the "Summary financial statement" for the year ended 31st December 2008. The following facts were gleaned directly from that statement.

In the year to 31st December 08, the chief executive had total remuneration of £346,000 (previous year £424,000) and was a member of Chelsea Retirement Benefits Scheme and so benefits from an accelerated rate of accrual. He will be entitled to a pension of up to two thirds of final pensionable salary at the normal retirement age. This person, along with most of the board, is a chartered accountant. Part of the chairman’s review of the year states the following "Regrettably, we have been impacted by a number of one-off credit crunch related costs and charges which have been detailed below and overleaf. Exceptional items. We have an exposure of £55million to two of the failed Icelandic banks and have set aside a provision of £44.3 million against these debts not being recovered. Both these banks operated in the UK and had acceptable credit ratings at the time the investments were made. We have also set aside a provision of £10.2 million for our contribution to the Financial Services Compensation Scheme in respect of the costs of bailing out failed banks and we have written off the goodwill of £15.4 million associated with our acquisition of BCS Loans and Mortgages Ltd. These items have acted to produce a loss after tax of £29.2 million" (26.6% of turnover - my figure and not quoted in the review)

Most people might be forgiven for thinking that Chelsea Building Society was a small comfortable establishment lending to the wealthy of Chelsea and only from money they have received from investors and depositors.

Meanwhile in the US, things are getting really nasty over the paying of bonuses to staff of the collapsed AIG insurance giant after it received $85bn of taxpayers money (there is another $88bn to come). It is even claimed that within the recipients of "retention bonuses" were 11 people receiving $1m or more each who had actually left the business.

The anger pot is boiling nicely and with the UK unemployment figure now over two million, is likely to continue.

The Real Boss Speaks Out

25th March 09 - The real boss speaks out

Mervyn King the Governor of the Bank of England has made a keynote speech to bankers at the UK Mansion House. It contained some real nuggets worth developing. He said that all regulatory systems around the world including the UK’s so called light-touch approach failed to "prevent the accumulation of risks that finally produced the crisis". I should say so, wouldn’t you? He then moved on to comment specifically on the practical outcome of the general approach of the Financial Services Authority. "A system in which it is easier for a large bank to expand and then destroy its balance sheet than for an individual to open a bank account has lost focus". I should say so. There was a business that received a personal visit from the local friendly bank manager in order to meet eye-to-eye and complete a form and view personal documents so that "the bank may prove that you exist". He had banked with that bank in that branch for over 20 years. Was the banker’s colleague securitising debt at the same time back at the ranch? Have you lost count of how many times you have sent off your passport by recorded delivery plus an electricity bill to prove you exist? I have.

Mr King went on to ask the Government to spell out how it planned to pay back the mountain of debt it had taken on following its bail out of the economy and the banking system. He emphasised that the central bank would specify its own plan for reversing the asset purchase it has taken on via quantitative easing. Now here is the real crux. "Banks are dangerous institutions. They borrow short and lend long. They create liabilities which promise to be liquid and hold few liquid assets themselves".  He warned against rushing into imposing new rules too quickly "Whatever exuberance - rational or irrational  - existed has been destroyed by the crisis. So we have time to reflect before we decide on the shape of a new regulatory system."

The odds are on the new regulatory system happening - real quick. A wise old owl stood on an oak etc.

Working Without Help

24th March 09 - Working without help

After yesterday’s stroll through the B of E’s Quarterly Bulletin of pessimism, it might just be that things are starting to work for the two UK listed banks that have not taken the shilling. This diary has consistently thought of Barclays as the maverick in the pack and its share price climbed 23% in a single day after it put out a statement that it was considering selling some assets. The objective is claimed to be the raising of £5bn. All the signs are that it will succeed in its ultimate aim of staying independent of the UK government by not participating in the toxic asset scheme as did RBS and Lloyds. Barclays reported a "strong start" to 2009. Some observers still think that allowing Middle Eastern investors to take 26% of the bank was a mistake but rather than relenting, it seems such supporters are in the frame to invest more. Not only that, these friends of Barclays might just be the buyers of some of the assets for sale. Barclays route to staying independent has been boosted by £6bn as a counterparty to collapsed US insurer AIG thanks to the US government.

Turning to the other bank, HSBC, Douglas Flint the finance director has said that it would be "unthinkable" for his bank to require a capital injection from the state. As Europe’s biggest bank, HSBC is in the process of raising £12.5bn from its shareholders via a rights issue (contrast the Barclays route) and believes it is doing so from a position of strength not weakness. Like Barclays it does not choose to use the toxic asset scheme. The Hong Kong based head of international operations, Paul Leech made a left-of-field observation "I think our balance sheet will be bigger in Vietnam at the end of 2009 than it was at the beginning". Let’s face it, you didn’t expect that.

If any meaningful conclusion can be drawn from these developments it is that maybe the law of the jungle is right after all. The weak should be allowed to die so the strong can pass on their genes.

Has Anything Worked?

23rd March 09 - Has anything worked?

After all the financial stimuli as recorded in this diary over the past months, it is worth asking the question as to whether, at any rate so far, anything has actually worked. In an attempt to answer this legitimate question it is worth reviewing the latest Bank of England’s Quarterly Bulletin. Here is a quote from Spencer Dale, the bank’s chief economist as set out in the report "Against the background of a significant and synchronised weakening in international economic activity, market conditions generally remained strained. In particular, bank funding markets became more difficult again reflecting renewed concerns about the scale of potential credit losses and write-downs facing banks". The bulletin goes on to say that the spread between LIBOR and expected interest rate levels had "started to widen again" while "contracts reported some increased reluctance to lend to banks beyond very short maturities"

According to an extract from the bulletin as reported in the Daily Telegraph, the main worry that investors have is the prospect that banks could be nationalised and that financial institutions are harbouring "ongoing balance sheet constraints". Oh dear, we all now know how to interpret that phrase. The bank warns that the credit default swap spread rates on large banks went to their highest level since just before the collapse of Lehman Brothers (we could call this the insolvency scare) and approaching levels reached in October 2008 - that is, when and why this diary started.

A postscript to the diary entry about Lloyds group’s capitulation to the Treasury is that the UK Shareholders’ Association has said that it is forming an action group for disgruntled shareholders and will now consider legal action over the recent events. A different aspect of discontent surrounds the apparent way in which it is claimed banks can so organise their activities as to run rings around the Inland Revenue.

Looks like there are more nasties yet to emerge from the wood shed.

To Meet And Divide

20th March 09 - To meet and divide

Upcoming on 2nd April, fortunately one day after April fool’s day, the heads of the world’s 20 most wealthy nations intend to meet to discuss what further steps can be taken to help pull their world out of the credit crunch crisis. We need not worry that this represents a cartel with such enormous monopolistic power that all competitive argument or action is thwarted. The fact is that the warm-up session of the bean-counters (that is to say, finance ministers) taking place in the leafy surrounds of the UK’s beautiful West Sussex has all the makings of a punch-up rather than a carve-up. The dichotomy of philosophical approach to the economic crisis has not eased over the past few months.

In the red corner we have the US and the UK. In the blue corner we have Germany and mainland Europe that it unofficially leads with its large economy and grinding efficiency. The US Treasury is pushing hard for a commitment from the rich boys to spend about 2% of their individual GDP on measures aimed directly at stimulation. Germany does not agree with this approach wanting instead to toughen up regulatory controls. The German Chancellor, Angela Merkel, is on record as saying "We do not think much of the idea of a new package of measures. The issue is not spending even more but to put in place a regulatory system to prevent the economic catastrophe that the world is experiencing from being repeated."

No matter what spin might be attached to the get-together, there is a fundamental split on what approach to take and if the top 20 are pulled in two different directions, the prospect of a best outcome is bleak. Enter World Bank president Robert Zoellick warning that the extra cash funnelled into the world economy will be no more than a "sugar high" unless troubled banks are rescued. Well, of course, they are being rescued in different ways and that includes in Germany. But, it is being done as well as fiscal stimuli. That seems to be the dichotomy. Who is right?

Manufacturing Down The Pan

19th March 09 - Manufacturing down the pan

The theory was that a weak pound would boost UK manufacturing and particularly those businesses pointed at export markets. One year on and figures from the Office for National Statistics show that the annual drop in manufacturing output has been 12.8%. This is the largest decline since 1981. Worse, in the quarter November 08 to January 09 a decline of 6.4% is the most dramatic since records began in 1968. The trend line is truly horrendous. Ross Walker of RBS said "The UK data serve to emphasise the severe and highly synchronised collapse in industrial output globally. Industrial capacity is being eliminated at an unprecedented pace, with few signs of any imminent alleviation". There was very little to advise on during my weekly visit to a factory making high quality furniture for the leisure industry. For the first time in 17 years, the shop floor was ghostly. All the men had been sent home, the machines stood as silent onlookers to the empty benches. For the first time ever, there was not a single order to work on.

Further official figures show that the UK trade gap in goods in January 09 widened by 7% to £7.7bn. Whilst exports dropped 4%, imports fell only 1%. The only bright spot was that exports to EU markets rose 6% and this is put down to the strength of the euro. But, exports to non-EU markets slipped by a massive 16% and to the US by 8.5%.

If the UK is to turn itself back into a maker as distinct from a service provider, the objective must remain as just that. There is no current evidence of the dream being realised. The expression pious hope springs to mind.

Oil Is Thicker Than Sand & Cement

18th March 09 - Oil is thicker than sand & cement.

It seems like an eternity since I wrote the article called "The House Built On Sand". It posed the question as to why the big house builders had not put finance aside for the rainy day to come. Some industries have had more foresight, more prudence or maybe boards that were more used to volatility in their markets. Oil companies are a good example. The basic product, a humble barrel of oil is what they invest to produce, what they refine and eventually retail. Just think that the price of this basic unit has fallen by $100 in seven dramatic months and now stands at only about $45. If the retail price of the average new house had suffered to that degree it seems highly likely that there would not be a single big builder left in the UK.

Yet, BP, Shell and ExxonMobil have not cut their dividends or investment plans. Why is this when, for example, BP is on record as saying that it needs oil at $60 a barrel to break even? The main reason is the strength of the balance sheet, what is known in accounting circles as retained reserves. The ability to ride out the storm by putting a few bob aside. According to JPMorgan, the current gap between costs and income at BP is £3.7bn. Shell will need twice that sum. But both can afford to borrow. Exxon has a good cushion due to having $22bn on its balance sheet. Shell has gearing that includes off-balance sheet obligations of just 23%. BP has an analogous strength. There is a great lesson to be learned from when the good times roll again, assume it will not last, put the odd coin in the piggy bank or oil barrel or bag of cement.

Lloyds 0, UK Treasury 1

17th March 09 - Lloyds 0, UK Treasury 1

It was a much heralded and intensely reported game which continued into two full periods of extra time. Some thought it quite boring with each defence tending to cancel out the other. Even the penalty shoot-out did not produce the usual excitement as the marksmen kept, inexplicable, firing wide of the goal posts. Finally, as most of the spectators had gone home, the UK Treasury centre-back feigned to the left and shot to the right so wrong-footing the goal-keeper as to score. The famous game can now be analysed in the cold light of morning. And a St Patrick morning at that.

The Lloyds Banking Group is to put £260bn worth of risky assets and impaired loans into the Government’s Asset Protection Scheme. This is the same insurance scheme agreed much earlier and much more swiftly with the RBS team. The assets now insured stay on Lloyds balance sheet but are "dealt with". Like all insurances, there is an excess to pay. The excess, or fee, is a trifling £15.6bn being 6% of the insured sum. Once claims are made, the bank takes the first 10% of the insured sum and then 10% of any further losses which amounts to a potential liability of £47.5bn. No wonder they needed extra time. Of all the assets now put into the scheme, 83% have come from the takeover of HBOS. The long standing old Lloyds/TSB shareholders are sore. Without that take-over their bank would by now be sitting pretty is not beating the Treasury team by a resounding 5-0 scoreline.

In terms of control, or maybe the correct term is nationalisation, the UK taxpayer will end up owning about 77% of the Lloyds Banking Group (but 65% of the voting shares) assuming that ordinary shareholders do not buy into the £4bn of government held preference shares now being converted to equity. Little wonder that, as the chairman of the bank so endearingly put it, the treasury team that started the match and stayed on the field throughout, ended up "knackered."

The Quantity Theory Of Money

16th March 09 - The quantity theory of money

The diary entry dated 13th March 09 reported the intention of the Bank of England to create £150bn of new money. Before the moment is lost, it is relevant to go over the  quantity theory of money now to be fully enacted and to list the unconventional moves that preceded this drastic step. The theory is this: the nominal growth rate of an economy can be no greater than the speed at which money is growing and flowing around the economy. That is why monetarists are not overly keen on those who choose to save. Savings tend to gum up the works apart of course from when the piggy bank lends out the savings for a productive venture or when a Middle Eastern or Far Eastern sovereign wealth fund buys up foreign debt with its savings to keep the Western spenders in business. But when the spenders get frightened off, the theory is proved in that nominal growth goes negative. The answer then is to artificially grow and, hopefully, flow the money supply. There are still plenty of sceptics about - artificial isn’t real is it?

The print money button was only pressed as a last resort. It is worth recapping on the three preceding steps. First came liquidity support. The Bof E invented a Special Liquidity Scheme. It lent money in return for collateral in the form of government or company debt and this has been going on for a year now. It has kept the balance sheets of banks afloat. Secondly, the bank bought debt as distinct from lending against assets. What were purchased were short-term company debts and corporate bonds. The mechanism was the creation of the Asset Purchase Facility and the cash came by issuing gilts, that is government debt. It follows that no extra cash was created. This is the route currently being followed by the Federal Reserve in the US. Finally the bank purchases existing government debt directly from investors and banks to try to bring down longer-term interest rates

There is one unconventional stimulus left. The bank prints money and literally hands it out to the populous and says look go out and spend or pay off your debts. It is not as far fetched as might at first sight appear. Japan is doing it already in the form of vouchers and Germany is giving away money to buy a new green car. It is called a "helicopter drop". So next time a helicopter flies over ...

Making Fiscal History

13th March 09 - Making fiscal history

For the first time in UK fiscal history, the central bank interest rate stands at 0.5% after a further cut of 0.5%. Effectively this leaves borrowing costs at zero. In what appeared to be a tongue-in-cheek remark, the Bank of England Governor Mervyn King said that further interest rate cuts were "very unlikely". In practice this latest cut means that using interest rates in an attempt to stimulate new borrowing has reached the end of the line. If further evidence of that fact were needed, then here it is

For the very first time, the UK central bank is embarking on a policy of money creation, or quantitative easing has it has become known. Despite all the hype accompanying the announcement, the role of the central bank has always been to regulate the supply side of fiscal policy, it is precisely by controlling money flow that interest rates are regulated. The difference here is that no amount of money management can now force the bank rate lower. The piggy bank is empty

Given the events of the last five months or so, it is easy to get blasé about the huge money numbers flying about. But these really are whoppers both in absolute and relative terms. The Bank of England has committed itself to spending £150bn of newly created money on buying corporate as well as government bonds. It will be split one-third on the former and two-thirds on the latter. How do we get these figures into perspective? Well, the entire corporate bond and commercial paper market in the UK is worth just £57.5bn (so it will double) and the amount of gilt-edged government debt eligible for the bank’s auction totals £250bn (so it will swell by 40%). For a further perspective, the first tranche of the inflow namely £75bn is equal to 5.4% of UK GDP. In total, the US Federal Reserve has pumped about $670bn into their system which equals 4.7% of their GDP

The objective of the central bank is clear, to stop the economy tipping into depression given that it is already in the severest recession since the 1980s. The risks are these:-

" Raging inflation in the future that is hard to stop

" Dealing only with the "supply" side of money with little "demand" side attention. The VAT cut has had little effect and Germany’s car dumping policy has not been picked up

" Further hurting savers especially the silver-tops who were, arguably, in the best position to support a consumer-driven economy

Today is Friday the 13th.

Razzle-Dazzle ‘Em

12th March 09 - Razzle-dazzle ‘em

In the diary entry of 23rd February 09 titled "Rock ya baby" it was noted that Northern Rock was just one year old as a Nationalised company. The accounts for that first year are now out and the headline number is a loss of £1.36bn. That’s how to razzle-dazzle ‘em. Let’s take a look at some of the "costs" that were charged before that loss was struck. £1.2bn came back to the taxpayer as interest and fees. £894m is shown as loan impairment, or in less posh terms, loan write-downs. £321m was the impairment cost of treasury assets, principally investments in the failed Icelandic banks and the collapse of Lehman Brothers. The small matter of £1.16m was paid as severance to the outgoing chief executive, £392,000 to the former chairman for his two month’s work. £210,000 was donated to charity due to that chairman but forgone and finally the tiny sum of £110,000 went as a pension top-up to the outgoing chief executive. Quite a gravy train and if we add these costs back on the assumption that they would not have occurred had the bank not got itself into the mess it did, then (if I have got the noughts in the right place) normal trading yielded a profit of a mere £1.057bn). You have to admit that is somewhat different. Razzle-dazzle, razzle-dazzle. Oh, and by the way, the bank’s tier 1 ration went negative at -0.4% compared with 7.7% the year before and the minimum 6% ish demanded of a commercial bank by the FSA.

And what about commercial factors? Not good. The number of customers in arrears on home loan payments by at least three months surged to more than 17,000 compared with 3,500 a year earlier and 170,000 homeowners were in negative equity which is almost 30% of the bank’s mortgage book. Current chief executive Gary Hoffman said "As the economic situation has worsened considerably, that has had an impact on our arrears and bad debt charges. That’s been the key driver of the loss" Really? What about the small matter of the interest on the government loan and the write downs on the loan book and the treasury assets and the pay-offs?

Another Cash Call, Another Bail Out.

11th March 09 - Another cash call, another bail out

HSBC (formally the Hong Kong & Shanghai Banking Corporation) which in the UK is the old Midland Bank and on-line is First Direct, has long been considered the most safe from the credit crunch. It has not featured alongside RBS and Lloyds and Barclays in the UK or Citigroup and Bank of America in the US as needing financial help. This is largely because of its perceived strengths in the Far East. But now only Standard Chartered holds the accolade for self substantiation. The news came as a real shocker and not just HSBC but the whole stock market reacted badly. A £12.5bn rights issue has been called, the biggest ever from a UK-listed company.

As the shares of HSBC fell 19% on the rights issue news, so the price of the already bombed out values of the other big banks fell in sympathy. Sympathy at a death of private ownership as some see it. What has made matters worse in terms of stock markets globally is the huge US insurer called AIG. This insurer posted, on the same day as the HSBC news, the biggest corporate loss in US history - $61.7bn in just the fourth quarter of 2008. The US government had to inject a further $30bn in emergency funds on top of the $150bn already provided. The sad fact is that this business is just too big to go under due to its international reach.

It is not as if either event, per se, was unexpected. But the scale of each was. Here are some of the triggered events.

• The UK FTSE touched a six-year low

• The US Dow Jones 30 company index fell to an intraday level last seen in April 1997

• Germany’s Dax index fell 3.9%

• France’s CAC 40 dropped 4.4%

• The shares of leading insurers were down

• Mining stocks suffered

• Brent crude tumbled to $42.98 a barrel 

• The pound fell a further 2.5 cents against the dollar to $1.40 and finally

• Gold fell $14.1 an ounce as forced sellers met their margin calls

Most worrying of all is that EU leaders decided not to support a rescue package for most eastern European economies.

Another unhappy day for the world.

Back In The US of A

10th March 09 - Back in the US of A

It is a long way from London to New York and yet in terms of restructuring the balance sheets of mega-banks, they could almost be in adjacent offices along the same corridor with no Chinese walls in between. No sooner has the ink dried on the deal to convert the original preference shares in Lloyds and RBS as bought by central bank in the UK to ordinary shares - objective being to improve the tier 1 capital ratio and reduce the interest charges on the preference share coupon - than it happened in the US. The US Treasury is proposing to convert up to $25bn of its original holding in preference shares of Citigroup into ordinary shares. There are two other consequences. First, Citigroup’s tangible common equity ratio will increase from 3% to nearer 8% (note that this ratio excludes goodwill as an asset) and secondly, the ownership by the US taxpayer will increase to about 36%. This level of ownership is not on the same scale of "nationalisation" as in the UK but who knows what will happen next?

The US mortgage organisation Fannie Mae, which along with Freddie Mac was effectively nationalised in September 08, is going to take a further $15.2bn from the US Treasury to stay afloat after recording a whopping $25.2bn loss in the last quarter of 2008. Peter Orszag, the White House budget director, said he was considering placing the liabilities of the two mortgagors onto the federal budget. This would be quite a hit for the US government’s finances since such liabilities amount to about $6.6 trillion.

The third piece of big financial engineering comes from General Motors. GM has confirmed plans to launch the UK brand Vauxhall and the European brand Opel as joint partners in an independent unit. The idea is for GM to retain 50% of the new unit but to find outside investors for the other half. To structure this financially, the new business would seek 3.3bn euros from European governments and receive 3bn euros from GM. There would be 1.2bn euros of cost cuts. For the sake of many thousands of jobs across Europe it is hoped this plan will work alongside the European Commission’s approval of the UK government’s plan to free up £2.3bn worth of lending for the car industry.

Worst Results In UK Corporate History

9th March 09 - Worst results in UK corporate history

Royal Bank of Scotland (RBS) has posted the worst results in UK corporate history - £24bn pre-tax loss for 2008 and made up of £8bn of trading losses and (how does one type this without the hand shaking!) £16bn write-down of goodwill. The latter principally from the acquisition of the Dutch bank ABN Amro and for which prize RBS fought and won an aggressive battle with Barclays. Once again regular readers of this diary are urged to read the article on this website called "Goodwill" noting specifically that this "intangible" asset represents the excess of actual payment over attributable asset value. A few bob is fair enough but £16bn!..

Now for the next squashed-fruit juicy bit. In one of the earliest entries in this website, the idea of a so-called bad bank being created in the US was lightly derided as being tantamount to being a big pile of rubbish and posing the question as to how that differed from individual small piles of rubbish (see "The US $700bn Bank Bail Out"). In the event the bad bank was not created and neither was one in the UK notwithstanding rumours that it would be. RBS is placing £325bn into the government’s insurance scheme. It is fair to call this scheme a bad bank within a bank. All this is a bit convoluted but when things take the direction that the current wind blows, it is inevitable. The cost of the insurance is £6.5bn plus an additional £5bn in deferred tax credits (the Revenue is saying ok you paid your tax in the good days but you are not having it back via tax losses). Like your home insurance policy, this insurance carries an excess clause. RBS will stand the first £19.5bn of losses on its bad assets and 6% of the rest. The taxpayer is in for the 94% that is left.

The last paragraph was about insurance and clearing the decks for the good assets to drive a new more conservative bank. What about re-capitalisation of that bank. Here we must take another deep breath. The government will inject £19.5bn in new equity designated as "B" shares (see the diary entry of 4th March). This new capital will help to pay for the insurance scheme and together with a further facility of £6bn will boost the bank’s tier 1 ratio to about 12% but this high level "will be eaten away by further losses and new lending". Who said so? The new Chief Executive does.

As a post script, RBS has to agree to lend an extra (extra to what?) £25bn for each of the next two years. If anyone is still awake and is a UK taxpayer, you should be grateful, you now own 95% of RBS.

Job And Van Losses

6th March 09 - Job and van losses

Job losses keep coming thick and fast and the one big point to stress is that they permeate every nick and cranny of society. The big headline is the announcement of 5,000 in a single day covering Tomkins (2,500), Bodycote (1,500), Barratt (700), Standard Life (195) and Carphone Warehouse (400). Saddest of all is the news from GKN, one of the very finest manufacturers in the UK. It is to cut a further 2,400 jobs this year on top of 3,450 lost last year (gaining jobs in fast food is one thing, losing skills at the likes of GKN quite another). Manufacturers, Housebuilders, Insurers and Mobile Telephone Retailers is a wide enough spread to prove the point but most UK householders are now affected. Individually smallish service sector businesses are having to retrench. Typically, firms of solicitors, accountants, architects, quantity surveyors and project managers have cut staff numbers and put the rest on a four-day week. Also typically in the professional firms, the salary cut is 20% whilst the people continue to work a full week, or at any rate the sellers and owners do. In total over 100,000 UK jobs have gone since 1st October 08.

Ian McCafferty the chief economic adviser at the Confederation of British Industry (CBI) said jobs were being lost across the "whole of the service sector, and firm’s expectations suggest that conditions will remain depressed for some time to come. Consumers are clearly reining back their discretionary spending, postponing holidays and spending less on leisure activities and personal care. Similarly, an already deteriorating demand for business services such as advertising, legal services and temporary office staff has slumped in recent months."

We all love to hate White Van Man and the main reason most vans do not have a business insignia painted on the side so you know who to have a go at after being buzzed at 80 mph in the outside lane of the motorway, is because they are rented. A company called Northgate is the biggest player in the van hire market both in the UK and in Spain. After a bad set of figures, the company announced it will cut its fleet size by 5,000 vans so it will only have 128,000 left and will write off £60m from its asset value as second hand prices fall markedly. But that is not the half of it. Please see the article on this website "Goodwill". Our old sparring partner called goodwill is being written down by £86m. There is a further direct link between this massive reduction in "asset" worth and an entry about Spain in this diary and a second article called "The Parable of the House Builders". Northgate cut 350 jobs last year.

Has The Housing Market Bottomed?

5th March 09 - Has the housing market bottomed?

First, let’s get the normal bad news out of the way. For the UK market, the number of houses changing hands slid in January 09 to the lowest level since 1959. A record low of 43,000 houses were sold according to HM Revenue & Customs. In perspective this quantity is about 25% of the not-so-long-ago boom times. Since stamp duty was suspended on cheaper homes in the summer of 2008, the number of houses changing hands has halved. Therefore, as has been said before in monitoring this crisis on a number of fronts, it is less about price than availability

But here comes the good news folks. The Royal Institute of Chartered Surveyors has detected some improvement and Halifax (perhaps the most authoritative of the watchers) reported a 1.9% increase in prices in January. Small but then so are green shoots. Simon Ward of New Star has said that house prices have now hit what might be considered "fair value" in comparison to rents. Figures form the British Bankers’ Association showed a small rise in new loans and at 23,376 it was the highest level for four months. Finally, Howard Archer of IHS Global Insight said "this adds to the overall evidence that housing market activity may have bottomed out"

Our old friend Northern Rock is being encouraged to do its bit. In a previous entry in this diary it was noted that the government had put £3bn more at its disposal with a promise of a further £5bn. But that was to undershoot. It seems that of the money lent to Northern at the time of nationalisation, some £9bn remains unpaid. The new board have been told to stop all efforts to pay this back but to lend it as mortgages instead. When we say "new board" we mean of course the UK taxpayer

Fill your boots you first-time buyer before the next plan arrives (from the hoof)

Make Up Your Own Balance Sheet

4th March 09 - Make up your own balance sheet

If you have a cold compress handy, apply it to the head now. In this complicated and technical diary entry, much attribution is made to two reporters in the Daily Telegraph namely Hugo Dixon and George Hay. The new US administration has indicated that any new capital pumped into the two big banks, Citigroup and Bank of America, will be in the form of a special type of preferred share convertible into common equity so as to keep the banks well capitalised. The apparent objective is to maintain "tangible common equity" (TCE). This is not a classification in everyday use but it means highest quality capital. Normally TCE is compared to tangible assets (TA). In the case of Citigroup, the ratio is currently 1.5%. Bank of America is 2.5%. Both are reckoned to be low.

On an assumption that a 3% ratio is wanted, Citi would need an equity top-up of $28bn and BofA $10bn. Such a position could be achieved by converting some of the existing $45bn government preferred shares. To calculate the size of the resultant equity stake of the US taxpayer it is necessary to fix a price for the conversion of preferred to common shares. If a discount of 10% to current market value was used, the government would end up with 59% of Citi and 19% of BofA. If the US administration wants to keep its holding under the 50% mark for Citi, it could achieve this simply be reducing the threshold to 2.5%. This is most likely what will happen.

Meantime back in Blighty the government looks set to restructure its £4bn of preference shares to save Lloyds £480m annually in interest (remember that the whopping coupon was criticised at the outset as forcing the bank to prioritise preserving profit before continuing to lend). This trick has already been pulled for RBS to save £600m in annual interest payments but at the cost of handing the government 70% of the business. But, wait for it, Lloyds might pull of a different technical feat. The preference shares might be turned into non-dilutive equity-like instruments so that the government’s stake stays at 43%. To go further, if Lloyds puts £250bn into the government’s asset protection scheme at a 3%-4% fee, there will be a cost of about £8bn annually. This fee could be paid for by a new kind of non-voting quasi-equity security.

And you thought you knew about balance sheets? Not the funding bit you didn’t.

The Chinese Begging Bowl

3rd March 09 - The Chinese begging bowl

The diary entry of 24th February dealt with the reluctance of sovereign wealth funds to buy the gilt-edged securities of the US and the UK on issue to fund the various stimulus packages. If international reports are to be believed, efforts at the highest possible level are being directed at facing down this reluctance. The new US Secretary of State has offered assurance to the Chinese government that the new administration intends to restore the health of the US public accounts and thus safeguard the interests of bondholders. This has to be done especially since Asian investors are so concerned about the sheer amount of debt being financed that the inevitable creeping inflation will lead to fiscal default come pay-back time.

The scale of US financing is staggering. The Treasury says it needs to raise almost $500bn in the first quarter of 09 alone and maybe $2 trillion by the year-end. This programme is to be launched as China and Russia are actually selling their holdings of US agency mortgage bonds. China already holds $700bn of US government debt but yet the begging bowl might still be rewarded for two reasons. First, despite the huge fall in Chinese exports, there is still an estimated monthly surplus on current account of about $40bn. It has to go somewhere. Secondly, Japan needs to drive down the price of the yen; what better way than to have another 2003 style US bond-buying blitz. Incidentally, the Euro and Sterling could be targets too.

Who would have thought it. Japan rescues both the IMF and the West and all due to a Chinese begging bowl.

How The Wheels Came Off

2nd March 09 - How The Wheels Came Off

There used to be a TV advert in which a car raced down a runway pretending to be an aircraft. The concept was to associate two high quality products from the same manufacturer. An iconic maker from a country renowned for its high standard of living, for sound engineering but above all for innovative design and safety. The country was Sweden and the manufacturer was Saab. If you were not quite in the Mercedes or Audi bracket, then the Saab 900 made just as good a statement. Whether or not the Swedes stood by their aircraft, they allowed the car marque to go West.

General motors of the US bought out Saab and have decided it is not generally motoring any more. At any rate, a threat is on the forecourt. Either the Swedish government offer financial support or else production of the Saab ceases. Saab employs 4,100 people in Sweden and there are another 10,000 with sub-contractors. Papers just filed with the Swedish court reveal it lost about £238m in 2008. Since this Scandinavian country has a history of free trade (Volvo went to Ford) and of not bailing out lame ducks, the writing seems to be on the bonnet for the stylish and different Saab.

This diary covered the grovelling of the chiefs of General Motors and Chrysler (and to a lesser extent, Ford) for state aid at its inset. Now, these two masters of Detroit have told the US treasury that they require $16.6bn of financial support. GM alone is planning to cut 47,000 jobs and is considering selling an equity stake in its European Opel brand and its UK Vauxhall marquee. In the UK, production figures for January 09 reveal a year-on-year drop of 58.7% and job cuts or production cuts have been posted by Vauxhall, Honda, Nissan, Toyota, Ford and Jaguar Land Rover. The latter looks the most vulnerable to a Saab type wipe-out because the Chairman of its new owner Tata of India said each of the group’s subsidiaries would "have to find its own way of sustaining itself". The company employs about 15,000 staff in the UK.

The Positive Investor

The positive investor

One of the earliest pieces published on this website was called "UK Stockmarket History". The idea was to give readers who were not familiar with investing and financial terminology generally, a basis for understanding what they were likely to be reading about and hearing about as the credit crunch crisis unfolded. Within that background reading was a heading "Choosing an investment strategy" and two such strategies covered were "Value investing" and "Contrarian investing". These two approaches to choosing which shares to buy have one thing in common: rowing against the tide and finding value for money. Attention is also drawn to the recent article on this website called "Going back into equities"

Alan Steel, the founder of Alan Steel Asset Management, an independent financial adviser firm, wrote a piece in the Daily Telegraph cautioning investors to beware the prophets of doom on the basis that the numbers do not stack up. His main points were these:-

• Estimates both in UK and US suggest that stockmarkets are 42% too cheap

• Corporate insiders are net buyers of shares in their own company

• In 1930, the year of the great depression, US GDP fell by 9%, the next year it fell by 6.5% and in 1932 it fell 13%. By contrast, in 2007 the US GDP rose 2% and last year it rose 1.5%

• Currently, monetary policy is very loose with interest rates at almost zero

• Job losses and mortgage foreclosures are far less than during the Great Depression

• Unemployment in the US shows job losses of 600,000, the worst since 1974 but the US labour force is 65% greater now than in December of that year

• Advertising is in decline and yet online advertising revenue is booming (the UK business Rightmove has just announced super figures, it is an online housing advertising site   the diary’s observation, not Alan Steel)

• In January 09, experienced investors in the US had 42% on deposit and on the last two occasions when they were at this level namely 1991 and 2002, it preceded the best two years to buy equities since 1987

• The average gain in the stock market following an incoming Democrat president replacing an outgoing Republican is 13%, 126 days later.

Of course, any independent financial adviser has a vested interest in persuading you to have a punt, but still, even trying to think positively is a reason to be cheerful not least when the FTSE has dipped to below 4,000 and is less dominated by financials

Sir Fred Goodwin’s RBS Pension

The pension fund - of playing ducks and drakes

The current headline scandal of Sir Fred Goodwin’s (the ex Chief of RBS) pension pot has diverted attention very nicely from the potential losses faced by the taxpayer as RBS dumped toxic assets into the new "Asset Protection Scheme". Everything in this life is relative. His pot is said to be £16m odd. The toxic asset loss could be £50bn! A good day (27th February 2009) to bury bad news you might say

Incidentally, if anyone thinks playing ducks and drakes with a pension fund is new and unique, read chapter 13 of Violets.