100% Mortgage? In a banking crisis?

Actually, the new Skipton product - 100% mortgage, no deposit, but (they say) stringent borrower qualifications required (primarily, a good prior rental payment record), plus a small interest-rate premium - all seems sound from the lender's risk-management point of view.  One assumes they'll be pretty careful about getting their own valuation done, too.  Structurally this is all good, pragmatic RM - and moderately creative, to boot.  

When Miss D got her first mortgage recently she was in pocket immediately (on a current account basis), the payments being less than she was previously paying in rent.  That's a dynamic the Skipton product arbitrages neatly.  Don't know if that situation prevails everywhere; but it does in her part of London.

Commentators seemed to be fixating on the potential for negative equity.  Well, yes - but both parties ought to be able to take an intelligent view on that.  On the lender's side, one assumes more pragmatic RM, relating to the specifics of the property and the profile of the borrower.  And for the borrower: hey, did you want (a) to get into property, (b) & without putting in equity - or not?

Go for it, Skipton.  Nice structure: hope you've got the details right.

ND

Banking Crisis - again ...

Commodities down on banking stress

Here at C@W we pride ourselves on having spotted the "2008" banking crisis in the summer of 2007, when two German banks went down, followed by Northern Rock - all three being canaries in the dank, dirty coalmine of culpably fatuous and irresponsible banking strategies being practised deep underground, that turned out to be systemic.

So what's happening now?  It doesn't look good.

• Silicon Valley and Signature
• Deutsche Bank (again) and Credit Suisse
• risk to economic recovery due to reduced bank lending
• likely response of the authorities: back to QE! (interest rates coming off already ...)

Thus far, the current banking woes have been accompanied by a pronounced downtick in commodity prices.  If, on the basis of economic contraction, that persists then maybe inflation doesn't just take off again with QE ... and people are forever pronouncing on the Chinese property market ... but I'm no good at predicting these macro phenomena.  (What's more, I don't know who is.)  Are you out there, CU?!

ND

Salmond, Boris: Neither To Be Trusted

It will be gratifying indeed if our old friend Badger Darling sees off the ghastly Salmond, or is at least presiding when the caledonian charlatan self-destructs.  Gordon Brown aparently hates the idea of his ex-Chancellor getting the credit both for this and 'resolving the banking crisis' (sic) , which is even better.

It's an odd set of circumstances that sees me having any truck with George Galloway, but his 'just say naw' line captures the matter nicely.  A poond's a poond fer aw that also seems pretty apt, and I'm guessing (from 500 miles away) that most Scots see it the same way.  I expect you'll have had yur tea fits in somewhere, too, in that conservative land. 

Yes, Salmond is as untrustworthy as he looks.  And so, I'm sorry to say, is Boris Johnson, who is clearly on manoeuvres yet again, and with the most inappropriate timing.  On the eve of a Union debate, the outcome of which is pretty critical for Cameron, who wants to hear BoJo announcing that we'd better get our minds around leaving the EU?  There are of course easy answers to that question, but none of them very edifying.

If Boris had been a consistent EU-skeptic there might be a scintilla of excuse.  However, he hasn't.  Quite the reverse, he's been a consistently opportunistic sniper at whatever has been Cameron's position, and in the past hasn't scrupled to let us know that contemplation of leaving the EU is the very essence of madness, and that the City of London would thereby be destroyed.

Much as we love these larger-than-life political rogues, at the end of the day we can do nicely without them.

ND

Bankers' Heads Should Roll, part 94

Channel 4 had an excellent scoop last night, a whistle-blower from the RBS 'Global Restructuring Group' who told how, in the wake of 2008 many of the bank's SME clients were transferred to the tender mercies of the GRG, which then systematically ramped up substantial and spurious fees to the point where - he alleges - not a few of them went under quite needlessly.  Then their assets were seized and sold at knock-down prices to an investment arm of RBS, he claims.  Needless to say, RBS protests its innocence.  

But Mr Whistleblower's story, replete with details and background 'colour', conveyed a strong whiff of plausibility.  Perhaps one of the several inquiries into Fred Goodwin's wretched monster will get to the bottom of it all.

Did I say 'whiff' ?  Stench would be more like it - the stench of decay.  'Global restructuring' used to be an honourable capitalist calling, and was (for example) in large measure responsible for accelerating recovery from the ghastly financial chaos in the Asian & Eastern markets back in 1997-98.  Likewise, in its heyday Enron's restructuring prowess was instrumental in digging many a floundering utility and large industrial energy user out of a hole.  The creative use of derivatives and various other financial tools and tricks of the trade is a wonderful thing to behold when used to assemble a win-win package that puts a company back on its feet.  

Of course there are rewards for the restructurer: a successful restructuring deal is as great a value-added proposition as can be imagined.  But - having done a few of these transactions myself - when you have a client who is almost in tears of gratitude for the service you've done them, you know the fees have been properly earned.

The official RBS response has been to claim that's pretty much what they still do.  But what Mr Whistleblower has described is a perversion of this noble art.  If he's right, then ways should be found to lock 'em all up. 

ND
   

Lehmans: Lest We Forget

History corner (guest writer: A.Pedant)

The airwaves are full of the 5th anniversary of Lehman Brothers going under, with people like Peston lazily saying that it marked the "start of the banking crisis". He really, really ought to know better.

The latest possible candidate for the start-date is a full 12 months earlier.  On 14 September 2007, Northern Crock went cap-in-hand to the Bank of England: and even before that a handful of German Landesbanken had gone under.  Each case was different, but only in detail.  And of course they were smaller: but when the canaries are dropping off their perches, the poison gas is already there.  We needn't bore you with a string of links to C@W posts of the time - but we could.

Why does this matter ?   Because no-one should be allowed to get away with either of these two fallacies, which we may justly term 'Brownite':
(1) Lehmans came like some bolt from the blue;  and/or (2) it all started in America.  The Brownite fallacies are an attempt to deflect blame from UK banking regulators and from, errr, Brown.  And of course Balls.

As I said, if you want the C@W links they are plentiful.  But for now, 'nuff said.

 
ND

Parliamentary Standards Commission into the BOE/Treasury?

The HBOS leadership team is roundly and rightly condemned for the horrendous mess they made of HBOS. Under their watch a stable, non-investment bank was turned into a leverage monster which has blown up to a cost of something like £25 billion to UK taxpayers and now helps play a key role in crippling Lloyds and holding back our economic growth.

As I have said many times before, what has been done should be a crime and these men should be facing a long stretch in chokey - luckily for them the inept system that we have for tracking white collar crime means they are free instead to spend their ill-gotten gains and live the life of riley.

However, these constant reports into RBS, HBOS and such like play so nicely into the zeitgeist of banker bashing. But we all know that the decisions these men took must be put into context. Alan Greenspan had pumped up a huge bubble of leverage in America and the Bank of England had willingly followed his lead.

Moreover, the UK Government was blinded by its tax receipts and was inclined to watch on, glad of the money coming in which it could use to bribe voters with unrealistic promises of public services.

So where is the report into the Bank of England and the Government ministers of the time? I hope they are just waiting for St Mervyn to retire before taking him to the Tower, but somehow I doubt it.

Banks and their Toxic Loans

There was an interesting article by Liam Halligan in yesterday's DTel, in which he advocates banks being forced to 'fess up to all their toxic loans forthwith. 

What's needed is "full disclosure", forcing the banks to recognise such losses, taking the hit, and moving on. Some banks would fail, of course, executive egos would be bruised and reputations would suffer. Banks would be restructured, while protecting retail and commercial deposits, with the weak being taken over by the relatively strong. Then, though, banks could recapitalise, the wheels of finance could once again start turning, and capitalism's "creative destruction" would be able to take its course.

Over the years, several of our long-time commenters have also warmed to the idea of precipitating a spot of creative destruction to purge the system.  In normal times, as a fervent free-market capitalist I'd be among their ranks: but just now I beg to differ.  

Back in 2008, one of the remarkable steps taken by authorities worldwide was to require banks to stop marking their positions to market, writing off or provisioning for all bad debt etc etc. - for the probably very well-founded fear that it would start an unstoppable avalanche.  I was surprised at the rapidity with which they did this, but in retrospect I don't think it was wrong.

(By the way, some of these new strictures - or perhaps we should say 'reverse strictures' - now apply to corporates, too: it is far less easy for them to make provisions now than previously.)

In other words, we may be sure that astronomic amounts of trouble are stored up behind the newly-erected walls of opacity in the accounts.  Release this deluge at your peril.  Has to be done eventually, of course, but under careful control.

(By way of an illustration of the prudent management of a far less extreme, but nonetheless dangerous situation: after Enron melted down in 2001, the gas and power sector was plunged into financial darkness.  Many highly leveraged power stations became worth very much less than the value at which they appeared on their owners' books.  Their banks were therefore in (relatively) serious trouble - these are billion-dollar loans - and the project finance sector froze for almost 2 years.

If any one bank had decided to write down its distressed power-plant loan book, a market valuation signal would have been established, and there would have been carnage.  But - even under the stricter rules of the time - by a miracle of, *ahem*,  spontaneous identicality of views being taken, this never happened.  The entire sector was quietly and very methodically restructured - hence the 'dominos falling slowly' effect I wrote about a long while ago - and three years later you would scarcely have known how close to the brink the system had been.)

Carefully does it, guys - there is a lot at stake here.

ND 

PS [for pedants only] - technically speaking it appears Halligan knows not what he is talking about. "UK banks need to maintain capital buffers against unexpected losses. Such "provisioning" is crucial in any economy."  Nope: provisions are taken against expected losses - it is risk capital that is held against unexpected losses.

Talking Point: UK House Prices

Here's a sweeping statement which has the ring of spin about it: 

"State-backed housebuilding drive would cause price crash, warns Fathom.  A state-backed housebuilding boom would not deliver the sought-after economic recovery, a leading consultancy has warned, but cause prices to crash and tip Britain's banks back into crisis."

Well.  I like to think I have a fair grasp of the laws of supply and demand; but also a bit of an intuitive reality-checker.  Can we really imagine house-building on a scale compatible with "tip Britain's banks back into crisis" ?

(a) we are already 'back in crisis'

(b) this needn't be a zero-sum game

(c) . . . ?

I am sure there are other arguments to be raised.  Have at it !

ND

MF Global: What Counts As Safe Anymore ?

A short while ago I wrote, can't recall where, that I'd assumed back in '08-09 the financial system itself might collapse - credit cards not accepted, wire-transfers not possible, funds frozen etc etc; but that apart from one Sunday evening when apparently the ATMs were nearly turned off, for most people this actually never really happened.

So - can we afford to be sanguine this time around ? Once again, I'm assuming not - and as Exhibit A we have the ghastly case of MF Global.

Hopefully not too many C@W readers have been personally affected by this; but some folks have been seriously harmed. Read this and gulp. When segregated client funds start going walkabout, the end is nigh. What - or who - is next ?

It's the reason (in my personal opinion) why sticking to physical is best if one wants PMs as a hedge against the worst. Even then, unless its under the mattress ...

ND

8 Banks Fail Stress Test: You Havin' a Laugh?

So, eight European banks have failed the latest round of stress tests, says the Grauniad. No, it's nine says the Telegraph !

Stress tests ? Give it a month or so and you can report the situation in fewer words: nine banks fail. Or ten. Who knows ?

If they ain't raised enough capital by now, they're done for. You may as well give front-line soldiers a medical just before giving the order to go over the top.

By a strange coincidence, the entire C@W team is out of the country just now... steady in the ranks, here we go

ND

Barclays Protium: Banksters@Work

The Barclays Protium story is utterly reprehensible: a major financial institution held to ransom by a handful of employees threatening to bugger off with the keys to the toxic waste cupboard unless paid an outrageous sum. "All that's wrong in the City", indeed.

One might say that such things happen on a smaller scale quite often, in many walks of life: but being merely egregious by its scale doesn't make it any the less shocking: a dramatic proof that people - be they bankers, trade unions or parliamentarians - will behave atrociously if not regulated properly.

But now a thing of the past ? No, rather a microcosm of how banks are playing their political and regulatory masters as a whole - see this story on their attempts to thwart Basel III.

This isn't really news, of course. But it's worth thinking through how one would conduct affairs at the corporate level to prevent a re-run of Protium - and then thinking how the same principles might be brought to bear at the macro level. We know about too big to fail. Are we to accept too big to be regulated ? Because if we are, let's not imagine this weakness will not be exploited ruthlessly.

A capitalist writes ... no rules, no game. And it's a good game - worth enforcing the rules for.

ND

Basel 3, Schadenfreude 2

A bit busy these days, but couldn't help pausing to smile over the angst that the new capital strictures of Basel III are causing across various European jurisdictions - you know, the ones who are pretty sniffy about the laxity of 'Anglo-Saxon' financing practices. And yet somehow it is UK banks that already meet - nay, exceed - the primary new standard.

'Twas almost exactly three years ago that the Schadenfreude 1 outbreak occurred at C@W, when two German regional banks were the first to go bust in the great Crisis. A bit unseemly I know, seeing what happened next at NR, RBS, HBOS etc etc.

Another thin smile is merited at the outbreak of: if you make us hold more capital, we won't be able to lend so much money. This is like the perennial traders' whinge: if you hold us to strict risk limits, we'll be forced to close out positions just when the markets are moving against us. In both cases the immediate answer is a dry - errr, Yes.

The longer answer is: OK, then we'll break up the banks ...

ND


PS - respec' to Pesto who is doing a cracking job at following all this

A Cauldron Boiling. Thunder. Enter the 3 Witches.

Here at Schloss C@W, we've been anticipating autumn for some while, and what will happen when everyone gets back from their holidays. It won't all be good -

... powerful trouble / like a hell-broth, boil and bubble

Hmm, mustn't get carried away. Long-term readers of this blog (Sid and Doris Bankers ?) will know my views on dominos - they fall slowly, and another of them is rocking gently. Yes, S&P have downgraded Ireland again.

"we believe that the government’s support of the banking sector represents a substantial and increasing fiscal burden, which in our view will be slow to unwind"

Now which other government hereabouts might need to think carefully about that issue ? Actually, it probably wasn't top of George Osborne's worry-list this summer, and there were some modestly encouraging results published in July from the UK banks. But they weren't so robust as to be proof against any weakening of retail activity or default-rates, still less a full-blown double-dip. Martin Weale, newly-appointed to the BoE's monetary policy committee, has thrown some eye of newt and toe of frog into the brew: yesterday he

"identified rising unemployment, falling house prices and a renewed banking crisis as the threats to the economy".

No rest for the wicked, eh George ? Harpier cries, 'tis time, 'tis time !

And so, back to Ireland: I shall be off to Cork again shortly (hip-flask at the ready, see comments here) and will report on local sentiment in due course.

ND


Update: tragedy looms and Steven L has done the Shakespearean business good & proper, see 5th comment below

"Stress-Testing" the Banks ? Not Very Stressful

Since 2008, on both sides of the Atlantic, so-called stress-tests have been and are being conducted by financial regulators to establish their capital adequacy. So far as I am concerned, anything that intelligently bolsters the limited, formulaic 'day-to-day' CapAd assessments made by the banks themselves is worth entertaining: we know that pre-crisis bank capitalisation was culpably inadequate.

Except that what is being done should never be dignified with the name of Stress Test. All the talk is of modest 'haircuts' to represent the downside of potential sovereign default: but as we wrote in 2007 when bank default was the issue of the day, nothing short of testing for outright default is sufficient.

Here is what the Bank of International Settlements - essentially the highest authority on the subject - says in its 2009 guidelines on the matter, written with the benefit of very recent Crisis hindsight and insight:

"Stress tests should feature a range of severities, including events capable of generating the most damage whether through size of loss or through loss of reputation. A stress testing programme should also determine what scenarios could challenge the viability of the bank"
(Principle 9, my emphasis)

Authorities please note: call a spade a spade, but don't call a haircut a Stress Test.

ND

Bank Lobbying Rumbles Into Action

The banks have been broadly on the defensive for a couple of years now but my capitalist media-antennae tell me they are drawing up the artillery in preparation for a struggle to get those pesky governments and regulators off their backs.

We'll be looking at some of this in detail shortly, but it's another nice day and so for now, here's just a reading list from the Sunday papers.

- From the Telegraph: HSBC doesn't want to be broken up

- Osborne is praised for rebuffing the EC on banking regulation (and quite right too)

- RBS doesn't want to be thought of as socially useless (and we certainly can't move for NatWest 'Helpful Banking' ads these days, can we ?)

- The Indy suggests that Osborne has already been nobbled

- From the Observer: PWC worries (on behalf of whom, we wonder ?) that if banks are made to hold more risk capital we'll all suffer (this is a really juicy issue we shall certainly be coming back to)

- And from the Scotsman, this time it's the Scottish wing of PWC worrying that, errr, Scotland will suffer (thus proving that it's part of a coordinated lobbying campaign)

What with the Bank Of Old Buffers limbering up on the horizon, the battlefield is getting crowded ...

ND

Spain: An Early Test for Macro-Prudential Mervyn

Ever since I first met CU, he has been warning that Spain would bring about the demise of the Euro; and we may be about to find out.

Whether the Spanish crisis goes the whole way, this type of event is akin to a Lehman or an Enron - a trigger for dominos to start falling. Systemic risk, in other words.

And of course Mervyn King has just been given responsibility for 'macro-prudential oversight', the cure-all for managing systemic risk. Let us hope he's been thinking about what it really means, he's had well over a year since the Turner report highlighted macro-prudential supervision as a missing art - in the UK, at any rate.

Distressed Spanish properties all round.

PS: see that Osborne has pulled off a 'coup' in persuading Hector Sants to stay on. Hmmm ... not sure about that one.

PPS: notice how many very well informed stories Pesto runs about the FSA and how wonderful it is ...? He's a great one for his sources, our Robert.

ND

Osborne is Right, EC Wrong on Use of Bank Levy

We don't expect always to agree with young George around here, but he's got this one right. If there is to be a Europe-wide special levy on banks, its application should be to general funds at the national level - by way of repayment for the bailout, if one likes to see it that way - rather than as a communal rescue fund for future bailouts. Even the Grauniad agrees on this one.

A year ago, the Turner Review mused on the idea that fully 'socializing' the ultimate risks of bank collapse might be "the optimal and only defence against system failure".

It isn't, and it couldn't be. As we said at the time:

"Conventional risk management can do much better than this without recourse to ‘state insurance’ ... What ‘society’ should demand is not the dubious privilege of socializing ultimate risk, but the proper implementation of conventional risk management between the consenting adults involved"

This is basic conservative philosophy. If you absolve anyone of taking care of their own business, they will at very least tend to be more casual about their affairs. We require property owners to confront the risks of fire personally, to arrange their own fire prevention, on pain of burning to death. The fire brigade (funded from general funds) is primarily there to stop fire spreading. Likewise, we must require banks, and their stake- holders, to confront their own capital adequacy - and the cost thereof - on their own. That is how risk will be driven out.

Michel Barnier, the EC commissioner responsible, is using the wrong analogy. "I believe in 'the polluter pays' principle", says he - and thinks that the payment should be into a government-held reserve. He should remember how this works in the realm of environmental pollution: unless firms are forced to curb their emissions specifically, they evaluate whether the fine is cheaper than the clean-up, and often opt to pay the fine.

You will not be surprised to learn that in the long run M. Barnier, statist froggie that he is, wants the reserve funds to be held by the EU itself. There is nothing more important for Osborne to resist than EU-wide (or even worse, UN-wide) tax-gathering, for banking, environmental, or any other purpose.

Hang tough, George, and you'll win C@W round yet.

ND

RBS Tries Its Hand - and Pushes Its Luck

Meanwhile, back in the world of banking ... without much press attention, RBS is trying to get away a fair-sized cash tender, offering to buy back a bunch of relatively high-yielding debt and prefs at a very significant discount – 40% or more - to face value. They do this at the same time as they declare a 2-year freeze on payment of coupon, as they undertook when they entered HMG’s Asset Protection Scheme.

Why would anyone sell up at such a discount, when (a) the amount of coupon they will be foregoing is a fraction of this, and (b) they’ve been able to sell in the open market at roughly the same discount for months ? (Today they are trading higher than the tender price.) The nadir of their market value – around 80% discount to face value - was of course March ’09, since when the improvement has all been to do with improvement of fundamentals.

So unless you see a decline in fundamentals from this point … Let’s see how this tender goes over the next couple of weeks.

Also on the RBS front - they may be suing Goldman Sachs for the payout they had to make in respect of insurance ABN-Amro had written on one of those *odd* product packages GS put together in conjunction with their shorting clients ... Isn't the real story how shockingly bad was RBS due diligence over the ABN-Amro acquisition ? We said (several times !) this was a crazy deal when it happened, and nothing that's come to light subsequently changes the position: by mid '07, Fred the Shred had completely lost it. Sue away, chaps - but it'll be embarrassing in court.

ND

That IMF Bank Tax Proposal : Why So Dumb ?

Amidst all the airborne clag and clegg that pervades our lives, the IMF has given the G20 the advice they asked for on new bank levies in the wake of the Crisis, to contribute (at a national level) to the costs of the bail- outs. It hasn't been given much airtime (Brown simply claimed they all agree with him), but it merits a quick look - not difficult, as the main text is less than 18 pages long.

Furthermore, it's mostly qualitative & non-technical, a very easy read, put together by folk who show a lot of basic commonsense and the ability to speak plainly - they slap town the Tobin Tax in no uncertain terms (tough shit, luvvies). There are also the usual handy factual appendices (did you know that the UK's financial sector contributes a lower percentage of total national tax-take than the G20 average ?)

But here's the curiosity. They recommend a 'Financial Stability Contribution' which

"would be paid by all financial institutions, with the levy rate initially flat [on a broad balance-sheet base]"

A flat rate ? Bonkers! Particularly as they then make the obvious point that we are trying to address risk: they say the levy could be

" ... refined over time to reflect institutions' riskiness and contributions to systemic risk"

Their excuse for this dumb flat-rate approach is of course speed of implementation: but they really aren't doing justice to the capabilities of the existing system. Financial institutions are well used to risk metrics: they all calculate some variant of the standard 'Value at Risk' measure, and are accustomed to having margin levied on them by exchanges using SPAN or an equivalent risk-recognizing system.

We can do this stuff already. Aim straight for the target, regulators, and go with a risk-based measure from the start - never mind Taleb and his Black Swan sophistry. It is rather important to get this right first time.

OK, now back to politics ...

ND

Repo 105 - Really Simple, Really Dumb

When the Lehmans ‘Repo 105’ story broke last week, CU noted the similarities with Enron. There are indeed some similarities – the bullying of external accountants to get dodgy treatments waived through; the reliance on convenient legal opinions - but there’s an even more compelling parallel. It’s WorldCom and the halfwit Bernie Ebbers, now languishing in gaol.

WorldCom, you may recall, resorted to the laughable expedient of capitalising $ 6 billion of expense - the simplest profit-doctoring scam imaginable. And the Lehmans Repo trick isn't at all complicated either.

Enron’s schemes, by contrast, were mind-boggling. Starting with ultra-complex (but legitimate) securitisations, Ken Lay’s boys moved on by degrees to transactions the structure of which even some investment banks found it hard to fathom. (“Actually unfathomable”, according to one academic.)

Everything about Lehman’s, from Dick “the worst US chief executive of all time” Fuld down, reeks of rank amateurism! Move up Bernie, you may have a new cell-mate.

ND