Infantilism over Interest-Rate Swaps

Kerr-ching !

It is possible to envisage the mis-selling of an interest-rate swap - see below - which would be deserving of punitive action.  But has this really happened on the scale we are led to understand ?  I find it very hard to believe.

Interest-rate swaps are not "absurdly complex" products as has been stated - in combination with a floating-rate loan they result in a fixed-rate loan.  What sort of businessman borrows millions who cannot understand this ?  And a 'collar' is only a tad more difficult.

We read that some borrowers were told there would be no loan unless they took a swap.  This means, the bank in question was unwilling to offer a floating-rate loan.  But (for various reasons we could go into) they frequently have a practice of quoting on a floating-rate basis, and swapping it out when the loan is agreed.  The two-step process is a bit unnecessary, perhaps, but it's how things are often done (and not just for loans - it's quite usual in energy contracts, too).

So - a very simple product, sold in a somewhat redundant two-step way.  And yet we are told that 90% of the borrowers hadn't a clue what was going on - to the tune of £10 billion in compo !  Someone's surely avvin' a lucrative laugh: and we are allowing the Great British Businessman, Mr Diddums, to walk away from any responsibility for his own affairs.

So what would have to happen for genuine mis-selling to occur (which, to repeat myself, would certainly merit redress) ?  I suggest it would need to be one or more of the following:

•  the bank rep lied through his teeth, and stated that the swap was in fact a call-option ('cap', or 'ceiling'), and would only operate if interest-rates rose
• the bank rep asserted strongly and convincingly that interest-rates were definitely going to rise, and that a fixed rate was the best choice
• the bank rep stated that floating-rate loans were not available anywhere, from any lender
• it was self-evident the client was as thick as shit, or spoke no English whatever (see below)
• the loan was much bigger than the client needed 
• the strike-price on the swap was way off the money (in the bank's favour) at the time the deal was struck

If 90% of customers can demonstrate one or more of those, I shall be very surprised.  They will take the compo anyway, of course, and a new claims industry will be born, adding several points to GDP growth.

Footnote: these little cameos from the Telegraph make interesting reading.  I particularly found the case of the non-English-speaking Turkish patisserie owner instructive.  Taking the numbers cited at face value, Mr Bey must have borrowed several millions.  Quite a patisserie, I'd say.

ND    

Gordon turns the screw on the Councils: Exclusive

Working on my theme of the week, unintended consequences, here is an exclusive to Capitalists@Work. No doubt the media will pick up on this later in the week.

The issue is the rapid interest rate cuts by the Bank of England. Rates have fallen from 4.5% to 2% in just a month; this huge change is said to be the cure to our recessionary problems

However, like in the Icesave case, Councils have been monitored by the Government to make the most of the money they collect. As part of doing this they have done all sorts of 'sensible' things, such as depositing money in high-yielding interest accounts like Icesave.

Now there is a new problem, Councils, Companies and all sorts of other organisations have 'hedged' their interest rate position through the use of interest rate swaps. However, these were hedged against rising rates. Falling rates means the loaning organisation (Banks) can call in the loans or charged penal rates.

This is very similar to the position Mitchells & Butler faced recently, which nearly bankrupted the company.

The net effect is lots of cash calls on Council's who have hedged against rising rates. Now they may have to sell assets in a tough market to raise the cash or borrow more to repay the loans - with Banks today charging very high rates, if offering any money at all. Banks desperately want the money to bolster their positions, they are not going to be lenient.

This is yet another example of what happens in a crash as Mr Drew pointed out so brilliantly a while ago. Actions are rapid and not thought through. What can seem like a good ides, like letting Lehman Brothers go bust, can turn out to be wrong very quickly.

Watch what the Government's does carefully, they don't know what they are doing....