When on 15 September 2008 the news broke that Lehman Brothers had filed for the largest Chapter 11 bankruptcy in US history I knew that financial war had been declared. Although I had no idea what the full consequences might be I had a greedy need to learn and a gut feel that only by recording the most salient events to come would this need be assuaged.
When I first set about this task I was in two minds about where on the Internet would be the best place to post – my website or a blog. So I decided to play safe and post the diary entries to both and monitor the statistics and feedback and make my mind up later. In time it turned out that my website attracted a loyal following and I became much encouraged by the number of regulars who felt there was more than enough material to actually go into print! – That’s how The Credit Crunch Diaries became Quantitative Wheezing The Book and jgwalkersmith.co.uk became Quantitative-Wheezing.co.uk.
As a preview of what you can expect to read in the book I’ve posted a month’s worth below for you to look at – I hope you find it as interesting to read as I did to write.
Welcome to The Credit Crunch Diaries.
I`m John Smith (yes really!) and I`ve spent a lifetime in business and business consultancy. As you can imagine I’ve been following the dramatic economic events we’ve come to know as the “Credit Crunch” with some interest.
Regulars to my Website at http://www.jgwalkersmith.co.uk/ccdiary.html have enjoyed the diary for a couple of months now but I`ve been persuaded that it’s time for busy people to be able to access the daily updates via RSS feeds and other means.
As well as the opportunity to reach a wider audience it would be interesting to invite comments from readers and start a wider debate.
The diary has been running for three months on my website but this daily blog will commence on 2nd Dec in parallel with the Website…. so if you would like to catch up with the events preceding this blog please visit my Website.
Thanks for looking in – John
01 December 2008 – double dichotomy
Oh what a tangled web we weave. Here is dichotomy number one. The UK banks are facing criticism and increasing pressure from the Government and industry representatives about the tough terms being imposed upon and general lack of support for businesses, particularly of the small to medium sized variety. There is even talk about passing a law although how it would be implemented is beyond me. Yet, the sheer expense of the taxpayer funding (see yesterday’s entry), that is the preference share coupon, and the conditions such as maintaining a Tier 1 capital ratio of at least 8%, restrictions on dividends and remuneration packages, and building profitability such that the price of the ordinary shares will rise to encourage the Government to get its money back, all mitigate against easing lending terms for businesses.
The second dichotomy is that according to statistics from the British Banking Association, lending to small businesses increased by £1bn in the third quarter of 2008 and a spokesman insisted that banks were making credit available despite the economic downturn. But added “Not all businesses will survive and not all business models that were established in the good times will survive a recession”. I personally empathise with this. The manufacturing business that I am involved with has consciously been building financial reserves for some time and although all overtimes was cut first and now the operatives are on a four-day week, we have enough fat to get through the winter. I am constantly astonished at how close many businesses (see my article on the big builders) have sailed to the wind.
2nd December 08 – Fall of the Pension domino
Now it is the turn of the pension lobby. The sharp increase in company insolvencies and particularly the size of failures such as Lehman Brothers and Woolworths, has caused the trade body for the pensions industry (SPC) to call on the Government to guarantee the Pension Protection Fund. A letter to senior politicians called for “a commitment from the Government to stand behind the PPF financially in a similar form to the guarantees now common-place in the banking sector”. It also called for a temporary amnesty on the levy imposed on companies with defined benefit schemes (final salary schemes) to fund the PPF
The number of retail businesses failing over the year to the end of November 08 is 17% up on the previous year and includes such past luminaries as Woolworths and MFI. The general view of retailers is said to be that the 2.5% reduction in VAT coming in force today (but effected by some big stores last week immediately after the pre-budget) will have no significant impact. The chief executive of one big store, Simon Wolfson of Next commented “The change will be administratively expensive, do nothing to stimulate demand and leave few feeling any better off”
The UK Government has indicated that it will have to take account of European state aid rules before deciding whether to formulate rescue packages for businesses and industries which are being starved of bank credit. It might be interested to learn that nations outside Europe have ploughed ahead anyway and that they may benefit from the lack of any such straightjacket
Is this the week for a further cut in UK interest rates?
UK banks in retreat – 03 December 2008
Other than in exceptional circumstances where a higher interest charge would be imposed to reflect greater risk, banks have always “secured” a business loan. At its weakest, this security would take the form of a “fixed and floating charge on assets”. This meant taking as security the deemed market value of fixed assets (see the article on this website called “How to read a balance sheet”) and also key items of current assets such as debtors, stock and work-in-progress that typically float, that is, vary by level of business activity. It is therefore a major sign of retreat post the credit crunch that banks about to lend to Centrica (the holding company of British Gas) at least £900m have been told that they must hold on to the debt rather than pass it on. This is to be a condition of taking part of the fund raising. Not only that but such banks had to agree to participate in extending loans if they wanted to underwrite a £2.2bn rights issue (for which of course they are paid). Remember that it was the passing on of debt having been bundled up that was the root cause of the credit crunch in the first place. The world fights back.
Meantime, Royal Bank of Scotland (RBS) has made a promise to give mortgage customers more breathing space by waiting six rather than three months before it begins legal repossession proceedings. So far, all the other major UK banks have refused to make the same commitment. RBS is, for all intents and purposes, nationalised but only has 5.7% of the UK mortgage market. This intransigence by the rest could soon be about to change however since HBOS which is by far the largest home loan provider will soon be merged with Lloyds/TSB and at that point will be 43% Government owned. Secondly, there is likely to be a bill put before parliament when it re-opens today to impose actions such as this repossession stalling upon UK banks. It would seem that the banks are in retreat.
4th December 08 – Feel your collar Sir?
Today is the day on which the Monetary Policy Committee meets. There is a high expectation of a further cut in interest rates. Some commentators think there might be a full 1% fall to 2% whilst at least one brave soul plumps for a cut of 1.5% to leave the bank rate at just 1.5%. Either of these would be dramatic indeed with the upside being a fillet for UK exporters and the downside the risk of a serious run on sterling. It is tempting to claim an upside for all those on tracker mortgages especially since most banks and building societies have promised to pass on the lower rates this time. But there is a snag. A snag affecting about a million homeowners. This snag comes in the form of a “collar”. A collar is a minimum rate of interest charge and it’s likely to be buried in the small print. The biggest two UK lenders, HBOS and Nationwide both have your collar to feel, sorry about that.
Turning our attention back to the US, the big three motor manufacturers are now pitching seriously for a share of the $25bn government bail-out fund. The car sales figures for November show just how drastic the downturn is. Ford’s US sales are down 29.8%, G M’s 41.3% and Chrysler is down 47%. This of course is not a unique American problem, car plants all over Europe are on short time or enforced holiday and the old adage comes into play. The bigger they are, the further they fall.
6th December 08 – of William & Mary
This is not a brief history of the Stuarts or about the style of the grand house or even about that splendid walnut inlaid dining table. Rather it is to date (1694) when the Bank of England came into being and to note that since that time interest rates have never fallen below 2%. But they are back to 2% now after the MPC cut by a further full 1% (a reduction it may be emphasised of 33.3%). Will it really make any difference? Two things need bringing out if only to help balance what could well be very skewed thinking. First, in the UK today, it is not the price of money that is at the heart of the difficulties. It is the lack of dosh. Secondly, in this same State we have six savers for every borrower. Has anyone thought about them? If ones income reduces from savings, does one go out and spend, spend or clip ones wings? This is of course a rhetorical question, but it has a grain of sense about it too. As this diary has argued before, there is something fundamentally flawed with fiscal efforts to motivate people to spend, spend, spend. To induce the creation of another credit bubble.
We all know that the banks did stupid things, played ducks and drakes with the regulators and with common sense. But, the banking system is at the heart of civilised society and of democracy. A sensible recipe for recovery would be something on the lines of
• Raising capital through equity and not borrowings
• Lend less
• Lend more at higher rates
• Hold a degree of gilts and other government debt proportionate to the new era but not overmuch due to its relatively low return
• Tighten lending criteria
• Get their middle management into clients that are struggling and offer financing advice
Everything I read about and observe currently is contrary to this approach.
5th December 08 – When China sneezes
China has the world’s biggest trade surplus. This surplus has been built largely on exports to North America and Europe. In an effort to reduce this trade surplus and realign currencies, China has allowed a crawling 20% revaluation over the past three years. This currency action has made Chinese manufactured goods that much more expensive in the export market and so mollified to a degree the angst of the importer and in particular the US. As we now all know, contraction of these overseas markets continues to be severe and it has hid China hard. The manufacturing sector has had the steepest decline since records began and worryingly it is reported that civil unrest has started in the Guangdong and Longnan regions. As noted in this diary earlier, in a major effort to stimulate the economy and replace the missing exports, China has unveiled a fiscal stimulus equivalent to 14% of its GDP. But that is not all. The central bank has moved the central peg of its dollar band twice this week, in other words it has, in effect, begun to devalue the yuan. This is exactly what the West does not want to happen and reverses the earlier practice. Furthermore, the chairman of China’s largest sovereign wealth fund has said he “does not have the courage to plough money into Wall Street and the City (i.e. London)”. This is hardly surprising since the fund has lost 80% of the money it invested in Blackstone, the US private equity fund, or $2.4bn. It has also lost heavily on its injection into Morgan Stanley (US investment bank) and Barclays the UK high street bank.
In an earlier diary entry, the question was posed as to who would buy the £billions of gilt edge stock about to be issued by the British government. Can we rule out China?
7th/8th December 2008 – Libor falls but margin stays
The London interbank offered rate (Libor) fell 9% to 3.38% as a reaction to the 1% cut in the bank rate this week. It is now at its lowest level ever which ought to signal that the banks are getting their confidence back to lend to each other. But those that know about these things caution against optimism because this wholesale rate is still 1.38% above the new bank rate and fundamentally it is this spread that really matters. Before the present credit crunch crisis, the spread was just .25%.
It would, however, be nice to think that money mobility is starting to improve whilst conceding that the bank rate itself has turned out to be near meaningless at reflecting the price of credit. This diary was enthusiastic about the introduction of the Special Liquidity Scheme (SLS) and maybe it is time to broaden its scope?
Job losses in the US continue to rack up. 1.9m jobs have been lost so far in this calendar year. Overall the unemployment rate stands at 6.7%, the highest for 15 years. Adding to the gloom, the Mortgage Bankers Association is estimating that 2.2m mortgages will enter the foreclosure process this year.
9th December 08 – Commercially speaking
One thing this diary has not covered so far is commercial property. The Royal Institution of Chartered Surveyors has reported that commercial property prices have fallen by 25% since the credit crunch crisis kicked in and we are talking about major office blocks and factories as well as all their smaller brethren. They predict a further fall of 25% over the next two years. This is of course a very serious matter for owners and investors in property-based funds. But it is also worrying for banks since they have loaned heavily to commercial property groups with the associated risk of default. There is an upside. Provided tenants are still in place to pay the rents, yields rise and coupled to the weakness of sterling, this just might bring back the foreign investor. Might.
There is an interesting debate raging amongst academics and commentators about what is left in the fiscal toolbag if interest rates fall to zero. “Quantitative easing” is a hard expression to grapple with but an easy one to explain. Supposing a central bank buys securities in the open market, for example treasury bills and bonds and perhaps also private debt (we will steer clear of equities for the time being). The result is to put the hitherto central bank money into the hands of the sellers, say the clearing and investment banks. As their reserves grow, so they will be more inclined to lend to each other and to their customers (see the piece on Libor yesterday). This last chance saloon can be tried and indeed has been tried in the past (Bank of Japan in the 1990’s). A central bank buying its Nation’s sovereign debt is a sort of a whirligig and you could say amounts to printing money. It can be overdone. Note present day Zimbabwe and latter day Argentina.
10th Dec 08 – City weeping
New figures from the Bank of International Settlements (BIS) show that global lending has dropped at its steepest rate since records began. Foreign lending by UK banks fell by $884bn so far this year, equal to 81% of the entire contraction in international lending. This lending is the core business of the City of London. Not only that, worldwide issue of bonds and securities has also fallen by 77%. Bonds issued in euros dropped by 94% over a single quarter. Interestingly the BIS also hinted that the ECB and the central bank of Sweden may have blundered by raising rates earlier in the year.
There is a bank that is planning to reverse a trend and lend more into the UK mortgage market but it is not one of those taking the taxpayers shilling, rather it is HSBC the biggest of the lot and with the strongest balance sheet. This will not be an act of charity but commercialism starting to operate again. As we have noted before, price is one thing, availability quite another.
It seems that even in the interregnum of Presidents, the US can still be fast and decisive. A $15bn short-term loan is about to be approved for the big three motor manufacturers. This figure is far short of the $34bn originally asked for and the bulk of what is on offer will go to GM and Chrysler with Ford wanting to bridge at $9bn “just in case.”
11 December 2008 – Germany declares war
This diary has commented before on how the German government has opposed the fundamental approach of monetary and fiscal pump priming to solving the credit crunch diary. This is notwithstanding that its own economy is in recession and its life-blood of manufacturing particularly heavy machinery and quality cars and trucks is draining away. Now it seems to be getting more polarised with a senior German minister actually criticising directly the UK approach and, in effect, leading Europe and the world down a route that it believes serves only to build debt for future generations to suffer.
We should return to the big picture. The World Bank is saying that there is a real possibility that global economic growth will shrink for the first time since the Second World War. The Global Economics Prospects report warned of a sudden dip in exports next year as appetites for goods and services around the world plummets. Here is a direct quote “Policy makers in both developing and high income countries must be prepared to weather a worst-case scenario of even lower growth, including the possibility of a decline in world GDP for the first time in the post-war period, as well as a financial meltdown that could lead to a sudden stop of credit flows to all but the most creditworthy borrowers” Quite a statement!
Meantime, things are far from well in the other military enemy of the last century. More than 1,000 Japanese companies went bust last month as the high yen (see an earlier diary entry on the causes of this) squeezed margins. The Government of Japan is planning last-ditch actions that include
• Issuing purchase vouchers to the public at large
• Pumping £146bn equivalent of fresh money into the system
• Possibly cutting interest rates to below the current 0.3%
• Quantitative easing (see diary entry dated 9th December 08)
Japan’s national debt is 170% of GDP, the world’s highest of this the world’s second biggest economy. Private savings have dropped from 14% of GDP in the early 1990s to just 2% today. One expert said that Japan has to re-balance its economy towards internal growth.
12th December 08 – Join the Euro?
It is a blasphemous thought for many but here is a quote from Peter Spencer, chief economic adviser to the Ernst & Young ITEM Club “You need a strong economy for a strong currency and there’s no strength in the UK economy”. Other commentators have gone further by claiming that the only way to stop a calamitous fall in sterling is for the UK to join the Euro club. The pound has fallen against a basket of world currencies to its lowest level since records began some 28 years ago. The euro is now worth 87.65p and that is the zenith against the pound since the launch in 1999. Furthermore, a pound will now only buy $1.48 and it seems only yesterday that this figure would have been over the $2 mark. A steep fall in sterling was always on the cards once sovereign debt started to ramp up
So where does money go once it leaves sterling? Well, one of two possible answers is US Treasury Bills. As demand causes the cover price to rise, so the yield drops and amazingly for three-month dated bills the yield has gone negative for the first time since the Great Depression of the 1930s. The second answer is a flight into the yellow stuff. Latest data from the World Gold Council shows that demand for coins, bars and ETF’s doubled in the third quarter of 2008 to 382 tonnes compared to a year earlier. To put this in perspective, such volume matches the entire set of gold auctions by the Bank of England between 1999 and 2002.
14 December 2008 – A pig in a poke?
So the shareholders of Lloyds TSB have consummated their long-heralded and largely enforced marriage to HBOS. A union forged in anger does not bode well and what a wife will Henrietta HBOS turn out to be? Contemporaneously HBOS revealed that bad debts will top £8bn this year. That staggering sum is worth repeating – £8bn – wow! Let us recall that the bank raised £4bn from a rights issue earlier this year and is set to draw down £11.5bn from the taxpayer, courtesy of the UK government bail-out plan. All this means that over 50% of this total funding will disappear from just one year’s bad debts. If that pig does not stink enough, let’s look closer. Writedowns in the mortgage book, impairments on credit cards and other unsecured loans and further writedowns on toxic debts are all very bad. But the real longer-term danger probably lurks in a double-skinned poke. First, the corporate lending book suffered a bad debt provision of £3.3bn. Secondly, the equity investment portfolio reported an £800m loss. If we think about the first case then, with the best will in the world, the figures can only be best estimates. They might be stuffed to clear the decks for the marriage but they might also be lightweight since HBOS has its fair share of “leveraged loans” to companies bought by private equity firms. Considering that, according to Thomson Reuters’ figures, private equity backed merger and acquisition activity in 2007 totalled £50bn, the HBOS tranche could mean there are more slugs yet to emerge from under the corporate loan stones. Returning to the equity investment aspect, HBOS pioneered a sort of partnership approach and it has been rumoured that they hold parts of hundreds of businesses, not all are small fry. How can it possibly be said that this year’s loss on these investments is anywhere near the last?
The board of Lloyds TSB might have taken a wise long-term decision and the pig might be fattened for a future Christmas. It might also wither away before it could be weaned. Certainly if, dear reader, you are like me a Lloyds TSB shareholder, the best adjective I can think of to describe the medium-term outlook for the new behemoth is “grim.”
13 December 2008 – Gnomes of Zurich on garden leave
David Bloom, head of currency at HSBC, says that the shift in policy by The Swiss National Bank is breathtaking “The SNB are the hard men of central banking; they are even harder than European Central Bank. What they are saying is that inflation is no longer a problem, it’s the solution. They want stimulus any way they can get it.” Uniquely, the banking sector makes up 20% of Swiss GDP and it follows that exposure to the credit crunch is extreme. Indeed, the liabilities of the big two Swiss banks namely Credit Suisse and UBS are seven times greater than national GDP. So what are the gnomes planning to do? First, interest rates have been cut to 0.5% and it could be that, amazingly, Switzerland will be the first European country to have a zero rate sometime soon. A spokesman for the central bank has said that they are considering a range of measures to follow the interest rate cut. Quantitative easing (referred to earlier in this diary – think of printing money), intervention in the foreign exchange (fx) market and buying up bonds are all under review. It is interesting to contrast this with the, still current, German approach discussed two days ago.
Sticking with Europe, there is growing criticism in UK circles that our banks are not, Barclays excepted, accessing so called cheap European money available from the EIB and earmarked for small businesses. France, Spain and the Czech Republic have sprinted ahead to grab a slice of the £1bn available.
Two days ago this diary, wrongly, said that the big three US auto manufacturers were about to receive $14bn ish of federal funds as a bail-out. Whilst the intended legislation got through the House of Representatives it failed to get the required 60 votes in the Senate. What will happen now? Will, in particular, Chrysler fall into bankruptcy? There is some talk of direct central government finance being put up without requiring legislation. It is a big, big problem stretching far beyond the US shores.
15 December 2008 – The pound in your pocket
The pound in your pocket will not be affected, as Harold Wilson famously once said. Like most political statements, it all depends on what you mean by affected. What it will buy for you certainly will be affected. The scale of the debt being taken on by the UK taxpayer in an effort to ease the credit crunch crisis and added to that which already existed to fund the public sector was bound, to a greater or lesser degree, to hit the strength of sterling. The pound is slipping closer and closer to parity with the euro. At this exact time it is trading at 1.11, the lowest since the euro was launched in 1999 and 17% down on the start of this year. It is also at a record low against a basket of other currencies. The overall approach by the UK government or perhaps the degree of this approach, basically buy now to pay later, has not found favour by Germany (dealt with in an earlier entry) and is questioned by the IMF and the ECB. Of course, a weaker pound makes UK exports cheaper for those still buying but means imports billed in local currencies are more expensive. That might not matter too much currently as exporters such as China struggle to retain volume but it certainly will in time. In fact, it is the classical way to import inflation which might seem a strange statement when deflation is on all lips. But, actually, everything that is going on at present will lead to inflationary pressures again. When you might ask. The last quarter of 2009 would be my best guess.
The awful problem of supporting the US auto industry drags on but meantime back in Blighty two actions are reported to be under discussion. One is to guarantee loans to the finance arms of the car companies and secondly whether to give low-cost loans to the industry directly, presumably out of the £400bn set aside to help the banking sector. The problem though is the same on both sides of the pond. Is the government intervening in a market that must sort itself out? Why select the motor sector? There are plenty of other worthy causes.
Fundamentally, I wonder whether the credit crunch is not a salutary warning to us all. Perhaps it is time to slow the world down a bit, start thinking about what we need rather than want. A dog cannot chase its tail for ever, sooner or later it gets dizzy and has to come to heal.
17 December 2008 – US Quantitative easing
The US Federal Reserve has now said that it is looking into the possibility of buying up US gilts and stands ready to extend credit directly to small businesses and households as well as expand purchases, announced previously, of agency debt and mortgage-backed securities. Some or all of this process has been referred to earlier in this diary as “quantitative easing” or euphemistically as “printing money”. This is emphasised in a statement made to Bloomberg News by William Poole a former St Louis Federal president “The Fed is sending a message that it will print money to an unlimited extent until it starts to see the economy expanding.” The plan to pump money directly into the US market would be a second layer on top of the headline news of cutting interest rates from the previous 1%. For the first time in 75 years, the Fed has ditched having a specific target for its funds’ base rate in favour of a “range”. This rage will be from, literally zero to 0.25%. It produces the lowest level for funds in history. The Fed’s balance sheet is already stretched and the likelihood now of further borrowings served to push the dollar down against both the euro and the yen. However, the US stock market, so far, has reacted favourably. This bold action is unconventional but not unique. Japan tried it in the 1990’s.
For the UK, the Governor of the Bank of England has just said that the action of pumping money into banks, and indeed partially nationalising three of them, is just not working to solve the credit crisis and that more funds will be needed to get lending back to something like normal. One leading economist thinks that full-scale nationalisation looks “almost inevitable.” The UK pattern of Treasury lending to banks and that was copied by other nations, is beginning to look at variance with the US approach described above although the UK might do its own spot of quantitative easing too. We shall see. The outlook continues to look bleak.
16 December 2008 – House of cards
In what appears to be the largest alleged corporate fraud in history and of which so-called “insiders” hold out little hope of recovering anything, a hitherto respected trader called Bernard Madoff (looks like there should have been a letter “e” in the middle of his surname followed by a hyphen) has apparently admitted losing $50bn. Although it is only about 24 hours since the devastating news broke, I have been contacted already by several people asking simply “where could such a huge sum have gone to?” The answer is simple too. I do not know. It is claimed that he single- handedly ran a pyramid rob-Peter-to-pay-Paul scheme in which the funds invested by later entrants to his US fund were used to pay out earlier investors. Another question relevant to this diary is “But is this disaster anything to do with the credit crunch?” Again, it would seem it definitely is since it was investors wanting to pull their funds to meet commitments caused by the crisis that lead to the house of cards falling down. Ironically, early indications are that two of the banks that have escaped relatively unscathed so far in this financial drama we call the credit crunch crisis namely Santander of Spain (who bought three of the big UK building societies) and HSBC are notched so far as massive losers.
As if by a second twist of coincidental irony, Britain’s Serious Fraud Office is planning to set up a dedicated hotline in the hope that professional firms of accountants, lawyers, bankers and those within companies themselves will whistleblow on corporate swindles. This website has an article on corporate fraud that has attracted a fair number of hits. The SFO is asking what type of frauds are likely to be perpetrated in the present climate, that is, what red lights are flashing. The tag line to this development is that this fraud office only deals, where individuals are concerned, with cases each over £1m in value. Have you noticed how £1m is now chickenfeed?
18 December 2008 – Euro from strength to strength
The euro stands at 1.44 against the dollar and 1.08 against the pound. Why has it got so strong so suddenly? It stems from a major contrast in approach between the ECB and almost every other central bank. The ECB president hinted this week that the bank may hold rates at 2.5% at least until the end of January 2009. Readers of this diary will be familiar with what is happening elsewhere and not least the US that shows all the signs of moving on from interest rate management to issuing money directly to the market. It follows that spare funds will flow into the euro even at what, until recently would have been thought of as, low rates of return. The strength of the euro can do nothing else but hurt the European states reliant as they are on increasingly expensive exports at the mercy of cheap imports. Eurozone prices fell 0.5% in November and deflation looms. The whole region is falling into deep recession. The biggest single economy that of Germany is expected to contract by 2% next year which would represent the worst slump since the Second World War. The economy of Italy is also thought to be in negative territory. To add to the worry beads, in an unprecedented move that has shaken Europe’s debt markets, Deutsche Bank has refused to redeem a bond issue because it would have been “much more expensive” to secure fresh finance in the current climate (quote is from Ronald Weichert, the bank’s spokesman)
In case the European tale is not stark enough, the losses and writedowns racked up by banks around the world since the credit crisis first erupted last year has hit $1,000bn.
19 December 2008 – As severe as ever
Commentators are saying that a move yesterday by Royal Bank of Scotland (RBS), which is about 57% owned by the taxpayer, indicates that the funding crisis in the UK is as severe as ever. The bank launched a third securitisation this year for £14bn to bring the total access to the taxpayer-backed Special Liquidity Scheme (SLS) – see earlier entries in this diary – to £34bn. Under the scheme, banks must securitise mortgages in order to swap them for highly liquid Treasury bills. Simon Ward, chief economist at New Star, estimated that Britain’s bankers have tapped the SLS for £210bn since it was set up in April. The official Office of National Statistics confirmed that it is making RBS part of the public sector. As a result, Britain now has the largest national debt in the developed world. The public sector debt is likely to hit £2.7 trillion, or 184% of GDP with the Government having borrowed £16bn alone in November month, the most in one month since records began.
The figure for Britain’s national debt now exceeds that of Japan which stands at 173% of GDP. Whilst we all had a restless night in the UK, the Japanese day started with the official interest rate being cut from 0.3% to just 0.1%. When one takes into account costs and spreads, in effect this amounts to negative interest. The thinking is, and bear in mind that the US is already there and the UK is heading there (we discussed Europe’s increasingly unique problem yesterday), that free money will stop the credit system freezing over. But zero is hard to fathom. If used as a multiple it turns other figures to zero too and in division it turns them to infinity. Infinity – now there is a word to conjure with.
20 December 2008 – U.S. still loves the automobile
After all the talk of Chapter 11 bankruptcy and then a so-called pre-packaged route to administration, the big three US car makers have been handed a reprieve. It may only be short-term and it may only be partial, but a reprieve nevertheless. Also, to say all three pleaded pretty much as one, the help is heavily skewed. The US government is to “lend” $17.4bn split as to $13.4bn to GM and $4bn to Chrysler. Ford stands aloof asking merely for access to $9bn “line of credit”. Where is the $17.4bn coming from? From the now infamous toxic fund of $700bn of course, so we are back where this diary started. Not that there is that much, actually only half has been released by Congress. For the record it is worth listing the cost of this gesture and the consequences. But first remember that these two manufacturers asked for $25bn earlier this month when presenting their business plan and GM alone has endured an estimate that it needs $40 -$50bn over the next few years.
In context then, $17.4bn is peanuts. Some peanuts. As regards cost, the fund carries a coupon of about 5% on non-voting shares. Also, there is a condition to cut wages to match foreign rivals operating in the US “non-binding” and viability by the end of March 09 “must be proved or the money can be recalled”. How will it be recalled? It is worth noting in passing that on foreign rivals, Toyota’s plants across the US are currently all closed, cheaper wages or not. Let’s think about consequences. David Silver, an analyst with Wall Street Strategies said “Today’s money only prevents bankruptcy for hopefully three more months”. So much then for the strategic short-term.
Will the US pattern be followed in the UK, do we love our cars as much? Well, there are two big factors over here. First, there are industries and sectors of industries with as big if not a bigger claim to central finance. And as regards employment loss, the retailer Woolworths had just gone under with twice the employee number as, for example, Jaguar/Land Rover. Furthermore, that business was bought out by Tata Industries of India, for better or for worse. Secondly, if financial help is forthcoming it will likely take the form of guarantees for loans by the finance arms of the manufacturers to try to get the credit lines flowing again even with stalled production lines. But there is one bigger factor still. In the UK it has been tried before with the old British Leyland. It failed abysmally. What the market needs is small and clean cars not big gas-guzzlers. You see it is a product thing, not a credit crunch thing. Once the economy picks up, the car lovers on both sides of the pond might just go for a new Toyota electric hybrid.
21 December 2008 – Recession came early
Official figures due out later this coming week are likely to show that the UK economic downturn is deeper and started earlier than had been thought. Revisions to GDP figures published previously would mean that Britain was in technical recession back in the first quarter of 2008. Figures for the fall in GDP during the third quarter are likely to be between 0.5 and 0.6%. Looking ahead, The Centre for Economics and Business Research predicts that Britain will contract by 3% in 2009 and a further 0.7% in 2010, implying a long and deep recession that will, by then, have lasted for three full years.
It is reported that the Irish government, that was one of the first to guarantee bank deposits, is to bail out its three biggest banks. This could, for example, lead to it having a stake of as much as 80% in Anglo Irish Bank. A total of 7bn euros will be injected most of it via preference shares carrying a coupon of between 7%-9%. However existing and new shareholders will be offered about a third of the new capital. Elsewhere there is chatter that HSBC will, after all, need to launch a rights issue and that France’s BNP Paribas and Germany’s Deutsche Bank are looking into fund raising options.
One bright spot in all this gloom is that a colleague of mine has a UK business manufacturing machine tools for export and invoiced in sterling. His main competitor is Japanese. This time last year £1 sterling bought 254 yen. Today it is nearer to 125 yen. “We are murdering them.”
22 December 2008 – Protecting the protector
John Ralfe, an independent pensions consultant, has calculated that if the motor manufacturers Jaguar, Land Rover and the UK arm of GM, that is, Vauxhall all went into Administration, the combined deficits of their pension schemes would be £1.5bn. This figure has escalated this year due largely to the 35% fall in equity values. And, as was hinted at in this diary two days ago, the likelihood of these businesses failing is not as remote as was first thought. A senior UK Government minister is reported as saying that the motor manufacturers must “look to themselves and their own resources”. We shall see but if this pensions deficit occurred, the UK Pension Protection Fund (PPF) would face a loss of “£400m -£500m depending on recoveries from the liquidation”. The PPF guarantees 90% of scheme members’ entitlements. Furthermore, the fund is facing the very real prospect of a raft of new collapses and will have to charge higher risk companies higher levies in future. Perhaps for the time being we only have to think of MFI and Woolworths but it is rumoured that the big UK Accountancy firms have a list of some 15 retail chains that could go under in the new year and maybe due to the quarterly rent demands now falling on the desk of each Financial Director.
My question is, who protects the PPF? Somewhere along the line, the barrel has to empty.
23 December 2008 – Funds contra-flow
In the final programme by Prof Niall Ferguson called The Ascent of Money and run on UK Channel 4, the subject of globalisation of funds flow was covered and specifically how the world has witnesses a contra-flow. In the 19th century big money left the West for the emerging markets in the East and not least on the back of the drugs trade. Contrast that with our 21st century when flows have reversed as cheap exports for the Far East took Western markets by storm leading to a “nice” situation (non-inflationary consumer expansion) that we all got used to. Although on relatively lower wages, workers in the East saved their money and invested heavily in their own domestic stock markets (the Chinese in particular where not allowed to invest abroad) whilst we in the West went on our now infamous spend, spend regime whilst we borrowed so to do. The net result was huge reserves building up in the East and indebtedness in the West. The East financed the West. Whirligig.
The problem with programmes like The Ascent of Money, which was otherwise excellent, is how does it cope with the fast-moving credit crunch times? Niall was filmed awe-struck at the sheer infrastructure expansion within the heart of China. But of course exports from China have reduced enormously, factories are closing (some 3,600 toy factories have closed this year) and huge investments by Sovereign funds have lost literally $billions investing in Western enterprises. So much so that there is a worry about whether the East will continue to buy, for example, British gilt-edged securities. There is known to be simmering violence in parts of China as ex-rural workers return home. Similarly, Japanese exports fell 27% in November, the steepest for half a century and the surging yen is playing havoc with the balance sheets of Japanese exporters. South Korea, Taiwan and Thailand are in a similar condition.
So, as Eastern surpluses run down, so fund flows to the West will slow dramatically if not stop and yet the West needs the money for its increasing debt mountain. So what would a further programme in the series cover? The Ascent of Money overall dealt with the crucial role that finance has played in military conflicts since the 13th century never mind the latest three. It ended with hints about Chinese/USA conflicting interests. We need to hope it was not too prophetic.
24 December 2008 – Tata source
So far, and although it could all change in the New Year, the prediction in earlier entries in this diary that the UK government would not rush in to replicate the financial help the US authorities have given to the auto industry, has proved accurate. Instead it is reported that the Indian owners of Jaguar/Land Rover have themselves pumped “tens of millions” of pounds into the business to head off a financial crisis. It must be particularly galling for the ultimate owners, Tata Industries, since this same conglomerate bought Corus earlier this year. Corus was the new name for what we all knew for years as British Steel. Like most commodities in this crisis of credit, the price of steel has plummeted and put that business too in jeopardy. Those of us with a medium-term memory will recall that British Steel has not exactly had a bust-free past. Steel and posh cars; what a combination.
As a small boy (memories captured in my novelette “Derbyshire born”) I tried to help my dad cut huge blocks of snow from the centre of the farm lane and move them to one side so that our horse had a chance of pulling through the farm cart carrying the two churns of milk that represented his sole income. I mention this because the year was 1947 and in middle England there has not been snow like it since. Neither has there been a worse year for Britain’s economy. The consensus is that the UK economy will shrink by 2.5% of GDP in 2009 building from a contraction in both the third and fourth quarters of 2008
This diary wanted desperately to find some good news for Christmas Eve. It has failed in that endeavour unless giving most employees of manufacturing companies not a week off for Christmas but rather a full month, counts.
26 December 2008 – Boxing clever
On this UK bank holiday (deserved or not) let us put aside the factual commentary on what has gone, and continues to go, bad in our post-credit crisis. Instead can we for once learn anything from history, even fairly recent history? At the end of the Second World War a bankrupt Britain had to face up to a class-ridden society that in the ensuing years of austerity would be totally unacceptable to the war-torn. Equal opportunity for the fighters and the sufferers back home has to be strived for. After that virtuous circle had almost completely turned, the productivity sick Britain now turned to an entrepreneurial spirit of self-help. Forty years spanned that gap and in the twenty or so since we should find the common factor and make it the foundation of our national recovery programme. That common factor is good old common sense, that is, assessing the times and people’s feelings and reacting accordingly. The credit crunch crisis is probably no more than a symptom of a disease. The disease is a consumption- mad society. A society in with spivs and sharp-practice merchants flourish.
If we stand back and think rationally, there are positives to take us forward into a new year. It is a fact that house prices have fallen universally but if we take the UK as an example, even on the most pessimistic of projections, general house prices at the end of 2009 will have reverted to those existing in 2004. What does five years matter? How were first-time buyers ever going to get housed had the situation continued, short of their parents dying? A correction had to come. Unemployment will swell but so it has before and we have come through it. This time around we have good training facilities in place and the UK is high on the international technology skill graph. A job switch is good, let us start thinking for ourselves again, let us create. Those losing their jobs need to be encouraged back into work and not become institutionalised benefit claimants. Furthermore the weakness of the pound has sent many migrant workers back home, get out into the fields and trade-starved homes and fill the gaps.
Of course we also need the right mind set at the centre. Markets must come back into their own, creeping totalitarianism must grind to a halt. The inefficient public sector must be shrunk until some degree of productivity is defaulted to. The army of highly skilled management consultants that are now pointed at state interventions and regulatory governance should instead be directed to the public sector to eat away at the fat.
The UK is not a lost cause. Whilst this diary will continue to monitor the factually bad stuff, it will also in its little way hope to find some pointers to solutions.
27 December 2008 – Down with property and equities
As 2008 comes limping to an end, it is estimated that in Britain alone some 32,000 estate agents have lost their jobs. This amounts to nearly half of those employed eighteen months ago. The consequence of the moribund housing market is that about a quarter of all estate agent offices are now vacant (circa 4,000) and for the rest, many continue with a skeleton staff of maybe a manager and a receptionist. Traditionally the business model has been one of earning fees as a percentage of sale price plus disbursements and so if sales die, so do fees. One assumes that for the future, a different model will evolve probably polarising into more on-line technology and more specialist time-fee based services for the up-market. We shall see.
Normally in this lull between Christmas and the New Year, we stock market investors assess how well we did relative to one of the major indices (see the article on this website “UK Stock Market history”). This year, however, it is different. The FTSE 100 has fallen by an unprecedented 34%. By comparison, the so-called dotcom crash of 2002 caused the same index to fall by 24.5%. David Buik, an analyst at BGC Partners said “There is nothing more toxic than fear and uncertainty to galvanise equity operators to dump their books unceremoniously . That’s exactly what happened in extreme degrees of volatility that had never before been experienced in the living memory of mature markets”. The biggest weekly fall of the year occurred in the week ended October 10th and amounted to 21.05%. It was the week in which the UK government unveiled its rescue plan for the banking sector.
Since most people are into property or stocks either directly or indirectly, most people have sore wallets to go with the seasonal sore heads.
28th December 08 – Pensioned off
Over the past few years the financial position of a pension scheme has come more and more into focus during merger and acquisition negotiations. This attention will intensify as actuarial calculations take into account the decline in equity values over the past year (see yesterday’s diary entry). For those businesses that still have a final salary scheme or an overhang from one, the potential resultant deficit on the fund is likely to be a key factor in any form of takeover activity.
Current speculation in the quality press suggests that it is primarily the pension issue that is holding up a deal between British Airways and Iberia the Spanish airline. It could also have been the main stumbling block to the muted plans of BA to join forces with the Australian airline Qantas. BA has two “defined benefit” pension schemes (see this website 99 Business Definitions – Stock market and investment terminology) and admitted back in September 2008 that the combined deficit has been calculated at £1.74bn, on an accounting basis. Since then it is likely to have increased notwithstanding that BA contributes £131m a year to the fund. John Ralfe, an independent pensions consultant, calculates that if BA were to sell its pension liability (the so-called buy-out basis) to an insurance company, it would cost the airline upwards of £6bn which is more than three times its current market capitalisation.
No wonder Iberia have independent actuaries looking into this non-Spanish, very British potential engine failure.
29 December 2008 – Down with commercial property
In the early days of this diary, it was explained why the UK high street banks had been forced to seek extra capital either by appealing to their shareholders or in default of that, having to take the taxpayer’s shilling. The reason was a mandatory increase in the capital ratio they were required to hold (called Tier 1). This increased ratio could now be breached such that more funds may be called for. It would happen as a result of heavy write-downs in the value of commercial property loans. Most property experts believe that values have dropped by 30% in 2008 and are on track to drop by 50-60% from the peak recorded in 2007. A study by De Montford University has found that the Britain’s leading banks have a total of £250bn exposure to commercial property loans
Meantime, it is worth listing the UK high street retailers that have already failed or seem about to fail as a consequence of the credit crunch or who did not shape their business model to withstand its consequences:-
MFI – Furniture
Woolworths – Consumer goods and music wholesaler
Whittard of Chelsea – Tea
Zavvi (Virgin megastore) – Music
The Officers Club – Menswear
Adams – Childrenswear
More names are expected to be added to this list before the end of January 09.
30 December 2008 – Savers hit back
This statistic is well known. In the UK there are six savers for every borrower. As a consequence of all the pump-priming that has been tracked by this diary, savings rates have dropped dramatically. As recently as three months ago, it was possible to buy a one-year fixed bond with a building society paying 6.9% and even 7.0%. Today it is a very different story. Figures just released by the Bank of England show that in the last quarter mortgage withdrawals were a negative £5.7bn, that is to say savers were paying their mortgages off. Contrast this with a single quarter in 2007 when £13.9bn was added to mortgages through the various equity release schemes. It just goes to show how hard it is for a central government to manipulate the financial market. They pump in money, even print money, in an effort to persuade people to spend on the high street only to find that those that did so before via mortgage withdrawal have gone away. What is the point of saving?
Before we close this year, here are two more startling statistics to go with the UK decline in the value of leading stocks that were quoted three days ago. The Japanese stock market lost 42% of its value in 2008 and the Australian stock market 40%. Those that prophesised back in the summer that the US led credit crunch would not be contagious, must be wondering how they got it so wrong.
31 December 2008 – More help for US autos
This diary has speculated that if financial help is given by the UK government to its car manufacturers, it is most likely to be in the form of money for the finance arms of the companies rather than directly. This might be because it could be seen less like favouritism for the high-ticket sellers whose customers usually need credit finance for their purchases. Once again, however, the US authorities have stolen a lead. The US Treasury is handing a $6bn lifeline to GMAC, the financial services division of General Motors and that is jointly owned by GM and Chrysler. The aid takes the form of $5bn of purchased preference shares in GMAC with an 8% coupon (there is also an option to take up to a 5% stake in preferred shares with a 9% dividend) and a $1bn loan directly to GM. As a result, it is understood that GM will offer customers a five-year interest free loan for new car purchases. This is a US only deal and does not apply to the UK Vauxhall brand of GM or to Europe. The financial package is in addition to the $13.4bn support for GM and Chrysler as detailed earlier in this diary. One final point is that GMAC has acquired the status of a bank holding company. This means it can access the $700bn toxic fund intended for banks in trouble.
As a postscript to yesterday’s diary entry, sitting alongside the UK, Japan and Australia’s steep fall in stock market values during 2008, the leading share index in Europe’s biggest market, Germany, fell 40.4%.