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.

Bank Downgrades

Are perhaps a little more important than people realise. Of course many will understand that if a bank is downgraded then the cost of its borrowing will rise. If like RBS and Lloyds your cost of borrowing is already higher than that of your competitors then this is bad for business.

Of course, what is really bad for business is that the solvent banks like HSBC do not want to offer all the lending that the market suggests they could - this leads to firms wanting to borrow to go back to RBS and Lloyds, even as the interest rates creep up.

So a set of bank downgrades will lift the overall cost of borrowing in the UK, albeit not by too much.

However, many of the more complex transactions that banks have entered into have various default clauses in them - mainly against the customer not paying the interest, but some on the Bank for non-performance. One such frequent clause is the rating status of the lending bank. Thus the bank can be in default on its own obligations - remedies for this will of course be costly for the Bank in question.

In addition, may banks are in the clover due to the Swaps they sold to protect against rising interest rates which then collapsed in 2008. This means the banks are in a big profits on these swaps, even the the assets they lent against have fallen in value. The twist of the downgrade is customers being in a position to negotiate a set off of one against the other.

None of this makes pleasant reading if you are a major clearing bank today. In as much as people don't care they soon will if the crisis continues to deepen and the banks seize up altogether, shafted by the complexity of their position and inability to cope with the macro mess politicians have created.

Independent Banking Commission interim report

At last we have the considered view of John Vickers and his team on UK Banking; albeit in interim form. Sir John makes a good case for the protection of retail banking in the UK in future.

The implicit suggestion is that by protecting retailers, other parts of banks can fail and the State will not have to offer blanket guarantees. However, the big miss here is the failure to really make clear how the Commission has viewed corporate banking. There is a use of a catch-all term of Investment Banking but this is not the same thing. If a major bank like RBS went down it would also take 28% of all UK corporate loans with it, this wold cause huge issues to the UK economy. The device chosen in the report of simply looking to only guarantee retail deposits does not really do enough to sort out the 'too big' part of the 'too big to fail' question.

For the Government there is much to cheer, criticism of the Lloyds/HBOS merger and a suggestion of further break-up; one in the eye for the former Government. However, the lack of break-up of Investment and other Banking is not much of a success for either George Osborne or Vince Cable.

I see many articles claiming that it was not investment banking that brought down the UK banks; Northern Wreck, HBOS etc. However, RBS, the biggest beast by a long way, was indeed smashed by its GBM arm. There is a strong case for banking to be split into utilities and casino banking; it would require a global level agreement but this should be pursued and not given up on. Alone, the UK is not in the best position to enforce this division as Barclays will go to NY and HSBC to HK.

The final main recommendation is the move to 10% capital retention over the current 7% of Basle III. What this means in that banks will have to hold over 30% more capital on their books in the form of cash equivalents. This will directly translate into lower overall lending; directly against the Government off-stated targets of getting the banks to lend again. Enacting this policy whilst we are not yet out of recessionary times will be madness - typical civil servant gold plating.

Laobour understand markets; Sell at the bottom

Long before Cityunslicker was writing this blog, Gordon Brown was showing his ineptitude in interfering with Capitalist markets.
The prime example of this is the gold sale, where he pre-announced the UK gold sale to the market, caused a huge dip and promptly sold into it. Now on the TV you often here Labour spinners saying we bought euro's so it was not such a bad thing as the euro has appreciated nearly 30%. Well, gold is up 500%, 30% does not even keep up with inflation over 10 years.

Fail.

Now over the weekend Alistair Darling has been flagging that he intends to play with the UK retail banking market to create more banks. Up to 3 new ones will hit the high street to try and make amends for the failures in the building societies and banks during the credit crunch.

Nothing wrong with this, I am all in favour of the mega-banks being cut down to size. However, you do not pre-announce such sales to the market. it is just stupid as you lower the price of the assets. Moreover, during a credit crunch, which seems to happen about twice per century, is the worst time to be selling bank assets. Talk about picking the bottom of the market.

Plus I am less receptive to the idea of this new retail banking market. The retail banking market is quite competitive even with only a few players. Much like the mobile phone market.

The real issue is splitting investment and retail banking up to de-risk the banks. Also to provide more competition in in Corporate lending where companies are struggling to raise funds.

So in summary, the Government has manged to get the timing and target of its initiatives wrong again.

Fail, again.

Another week of Banking to come...

As if plenty of people are not bored with banks already, after last Friday's Lloyds/HBOS announcement there is more to come this week. Paul Moore has more which might undermine Gordon Brown further, if that is possible and speculation like this, on RBS will continue.

The last couple of weeks was interesting as the short sellers cleared out of the UK banks and the share prices recovered somewhat. It will be interesting to see if they dive back in on the Lloyds/HBOS news of whether the risk of nationalisation keeps the stocks too toxic even for short-selling.

And then there is the bonus row, which surely can't last much more of the media cycle as it is getting very tedious now...

All clear sounded, Barclays up 73%?

Well, my post on BARC yesterday proved to be right. Today was a day the markets decided that perhaps Barc and its muckers are not quite as screwed as we thought. Interesting to note that Barc's write-down loss was actually as much as RBS, sans ABN-Amro.

Even Lloyds perked up. As the US is steady tonight in terms of close I would not be surprised to see the rally continue a bit tomorrow before profit taking on Wednesday or later in the week.

So the question in the media will be, is this it? Did 'we' just win the high-noon shoot-out?

Sadly, I think not. There is another delay until the next leg of the crisis in a few weeks. I note Gold and Silver have spiked to over $900 and $12 respectively and are staying there. In the US another bank went down on Friday - there is a long-way to go yet. The UK Government's insurance plan is not a bad one, albeit very late in the day. However, if banks balance sheets deteriorate again there are no bullets left. Nationalisation will make us vulnerable as Iceland has been.

A good battle, but the war is not going well overall.

RBS share price down 70%: We said this would happen..what now?

Ending the short-selling ban has not worked, as predicted. Bailing-out the banks without suspending the shares has not worked, again.

The government has repeated the same mistakes it made in October.

Ideas to move forward are desperately needed, feel free to discuss in the comments...

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....

Radical Solutions; Suggestion 2; NewCo Bank

The other day I posted about using a monetary stimulus, printing £'s that is as a possoble solution. This had a mixed reception but I was glad to see the idea being discussed on Newsnight on Friday; so maybe not as barking as some would have you believe.
There are of course many problems with that idea (see comments to the article) but it is going to do more than cutting VAT by 15% for a year or so which is the Government plan plus a few small tax breaks for their client estate Labour voters.

The next proposal I have is more radical and is inspired a little by Anti-Citizen One's comment on my blog months ago.

Our banks are bust, they have far more toxic assets than they can cope with and are slowly going to die or be nationalised. All banks have the toxic virus as they all bought into the real estate bubble and structured finance con.

Yet businesses are crying out for loans, people need mortgages and car loans, the economy is stuck with a terrible monetary collapse - fiscal tax increases are not the answer (at least David Cameron get this as he said on Marr this morning in a very impressive interview).

What we need is a new bank or banks, one unemcumbered by the debt. Then the old ones can be wound down over time and the new ones take their place. So what is stopping this? Well a new bank needs a lot of capitalisation (hard cash), a branch network and lots of staff. Fortunately all these are avaiable for a song right now. The UK Government already owns the Norther Wreck and Bungle and Binglie networks and staff and could make better use of its assets.

Instead of a further investment into the likes of HBOS, we need new national champions - let the shareholders and bondholders in failed companies take the strain and not taxpayers.

Set up a new bank or two and then sell them to the private sector (most likley private equity coompany at first). They will have such a huge competitive advantage they will soon be able to clean up the monetary mess we have in the UK. Much of this work is already done, it just needs courage and some imaginantion to get it going.

Thoughts?

End game approaching faster than the Government can cope with.

On just Sunday, which seems a lifetime ago, I wrote the world faced meltdown this week from a variety of factors. And Lo, it has come to pass.

Horrendous mismangement of the PR by banks and the Government has allowed a delicate situation to snowball into the worst banking crisis of our lifetimes in the UK.

RBS is now on the critical list. Either the Government 'does an HBOS/Northern Wreck' or we have a failed bank on our hands which will push the UK over a cliff and probably mangle our financial services business for ever.

I detest government intervention, but hold my nose when all our futures depend on it. Saving northern wreck was political, saving HBOS and RBS is not, a systemic failure would be more expensive than the bail-out.

I detest cack-handed government intervention even more, but that is where we are. There must be a huge day of reckoning to come for the Government and leading bankers when the actual crisis is over.

At least re-capitalisation is the right idea and the US have kick-started the commercial paper market. At the 11th hour I hope it is not all too late...

UPDATE: The deed will be done in the morning. Fingers crossed now. If this does not work the lights will be out soon.

US Bail out bill fails; Dow down 750

Now what?

I can't face looking at my portfolio in the morning....

Those pesky short sellers...

UK bank share prices today, post the short selling ban:

Barclays off 9%
Lloyds off 13%
RBS off 17%
HBOS off 12%

Must all have been their fault, closing out those short positions....

Bradford & Bingley 'rescue'

The line has to be drawn; this is a small UK lender. There will be no global impact of B&B going bust.

Let someone buy the good bits (i.e. the deposits) and anyone can get the mortgage book on the cheap, which should make up for the default ratio. The administrators can easily sort this out.

Then the rest can be liquidated, shareholders, creditors and bondholders losing out.

Sadly, my hunch is that it may be rolled into Northern Wreck....

SUNDAY UPDATE: So it has come to pass. B&B will be rolled into Northern Wreck. Watching David Cameron on Andrew Marr this morning the Tories have a better plan than the current Government in terms of re-doing the powers of the Bank of England. However, the essential point remains that there is no need for the country to 'save B&B.'
Where is the systemic risk from this relatively small provider going down?
The Government have a taste of nationalisation now and no doubt will be singing the red flag in the commons again when they next get a chance.

Learnings from a day of chaos

At least I am not clearing my desk like those at Lehman Brothers, however it has been a truly terrible day for the US and UK financial sectors.

To lose 2 major investment banks in a day in the US is more than careless. It also shows the futility of the nationalisation of Bear Stearns, so much US taxpayer money down the drain. By implication the same is true of Northern Rock.

I don't know what the US will do about the request for help from AIG, but it seems sensible to ask them to go away and sell themselves. We will find out tomorrow.

In response markets have fallen, the sky is falling in being the cry. Yet oil fell in price today and gold did not shoot up. Commodity falls are a good thing, they lower future inflation and will allow the Bank of England to cut rates over the next few months as inflationary pressures ease.

But the worry for the UK is our banks, HBOS is heavily exposed given its funding model and mortgage profile. Not surprising, its shares fell heavily today. RBS and Barclays are in the mix too and even HSBC.

Coudl it happen here? Yes.

UPDATE: Looking at things overall, will be interesting if a hedge fund goes down because it was stuck with all the stock it was trying to short...must have hurt George Soros quite a bit.

"US bank to fail"...UK banks too?

Credit market turmoil has driven the U.S. into a recession and may topple some of the nation's biggest banks, said Kenneth Rogoff, former chief economist at the International Monetary Fund

This is the latest news to hit the US markets. Of course Bear Stearns has already been palmed off to JP Morgan. In the UK we have had Northern Rock and Alliance and Leicester has an emergency sale of itself to Santander to prevent collapse - just today it has acknowleged that in effect it cannot survive if the sale falls through.

Bradford and Bingley is also only fit to prepare itself for a fire sale.

This is not a good run of events and clearly the weak are already fallen. Now what is being discussed is some of the larger beasts also succumbing to what is effectively financial gout; Bursting with debt and greed they can only stagger to a final fall.

In the US Lehman Brothers was considered just a few weeks ago as in a serious state. It has just put up a big part of its business for sale, scotching the current view that the driving down of its share price was all just speculation.

In the UK the main banks have fallen again today - but could one of the big ones collapse? It is still a distinct possibility. With no more access to the capital markets, the government spent out on Northern Wreck and high costs for bond issuance the banks are very much stuck.

HBOS, RBS, Barclays and Lloyds in that order are under threat. HSBC seems too big to fail but its frankly unfeasible scale of CDO's and other toxic mess could even hurt the biggest beast of all.

But will it happen - I am not sure. What I can see is a third leg to the credit crunch, with a consequent retrenchment from the gains of recent months and so another 'test' for our financial institutions. More will be found wanting if this occurs.

Are Barclay's playing the hiding game?

I have no info but am surprised, as are most analysts (of which I am not btw), that barclays is able to declare all its nasty leveraged loans as non-toxic and requiring minimal write-down. In addition its UK write-downs on cards etc are very low.

My hunch, based on instinct and no data, is that there is some arbitrage going on here. Whilst Barclay's maintains this position it can borrow and lend in better circumstances than its UK rivals, HBOS and RBS. As such it is hoovering up mortgage share of the market by way of example.

If and when it 'comes' clean, then it will have bolstered itself at a time when the opposition was caught low. This is a dangerous game if that is what is being played.

Otherwise they are just really lucky the ego's of their management team last year lost out to RBS, sparing shareholders the denoument of acquiring ABN and then writing off most of its value within months....

HSBC Half-Right?

The normally excellent Robert Peston has his thoughts here on HSBC's results this morning. Following on from LLoyd's 70% fall and the disasters at HBOS and expected at RBS - these HSBC results seem to be a shining star.

However, looking at the writedowns they have more than written off now their entire investment in HSBC USA; why don't they just close the business altogether?

Also they are still taking huge write downs, bigger than their rivals. HSBC moved some of it's SIV's (enron-style accounting that was previously hidden) onto their balance sheet in January and are now slowly writing this off. The difference with HSBC is that it has the capacity to do these write off's over time.

As such it will be many quarters before HSBC returns to it previously profitable position. Only by compairing to other banks can this be seen as success....