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Archives for June 2008

Barclays and the FSA

Robert Peston | 09:17 UK time, Wednesday, 25 June 2008


It's been an open secret for weeks that Barclays was trying to raise more than £4bn through the issue of new shares - although as recently as 24 April, its official spokesman told me that a statement made that day to Barclays annual meeting by its chief executive, John Varley, meant it would not be raising significant amounts of new capital.

Barclays bank signIn the context of the turmoil afflicting the big global banks, I was bemused by the unambiguous spin.

I had interpreted Varley's words as implying there would be a sizeable sale of new shares, but I was told in no uncertain terms that I was wrong.

Barclays put me in a difficult position. I did not believe that it would be able to go through this very difficult stage in the banking cycle without strengthening its balance sheet. But that was my opinion (albeit informed by knowledge of what the regulatory authorities wanted) - and it was being contradicted by the bank itself.

What perhaps is more troubling is that even today, when making the formal announcement that it is raising £4.5bn through the issue of new shares, the bank is still sending out confusing and apparently contradictory messages.

For example, its statement on current trading and prospects implies that it's doing well - although a close reading of Barclays' words makes no commitment about the out-turn for this year.

What Barclays says about its capital ratios, those regulatory measures of its financial strength, also begs questions. As Barclays pointed out on 24 April and repeats again today, one of those ratios was above target and one just a fraction below. And the new £4.5bn will take the ratios well above international minimum standards and Barclays' own targets (which the bank is not changing).

So if you were an intergalactic investor just landed from Mars, you would be scratching your head and wondering why on earth Barclays wanted £4.5bn from new and current shareholders.

The answer is that banks are insured, regulated institutions and therefore cannot ignore pressure from the Financial Services Authority, the City watchdog.

It wants all our big banks to have a significant cushion of capital, and has made that abundantly clear to all of them.

The tit-for-tat of the Bank of England's £100bn mortgage collateral swap - which Barclays was influential in negotiating - was that the banks would do their part in shoring up the financial system by raising risk capital.

As I've written, it was the FSA which forced Bradford & Bingley to raise emergency funds from Texas Pacific Group, the private-equity giant, when its rights issue was on the brink of collapse.

And now that Bradford & Bingley's big shareholders have taken my advice and come up with their own competing recapitalisation plan, the FSA will look under the bonnet of the banking takeover vehicle being constructed by the financial entrepreneur, Clive Cowdery.

I also have no doubt that the FSA will ensure that Alliance & Leicester, the medium-sized bank, finds safe harbour from the financial storms.

But back to Barclays. I'm not saying that the FSA issued it with a formal legally binding instruction to issue new capital. But who do you think is more chipper this morning, Barclays shareholders - who have been asked to dig deep for precious funds - or the regulatory authorities?

Hail new King

Robert Peston | 19:29 UK time, Thursday, 19 June 2008


Credit where credit's due (as bankers forgot in the years of the borrowing binge): Mervyn King has won almost everything he could possibly have wanted in the aftermath of the run on Northern Rock.

The chancellor has announced that the Bank of England will have formal and legal responsibility for financial stability (it's rather shocking to learn that its current responsibilities in this area are non-statutory, that they are a boy scout's promise to do his best).

The bank will also take charge of the process of managing bust banks to protect depositors - which is what the Tories and the Treasury Select Committee had been urging, but the government had been resisting.

It's worth pausing here a second. Because it's notable that the supremely confident Treasury has conceded intellectual defeat to George Osborne, the shadow chancellor.

The Chancellor, Alistair Darling, may well have been shrewd not to fight this battle. But his predecessor, that chap who is now at No 10, would have ripped out his own tongue rather than adopt a Tory proposal.

And there's a second sense in which the government has had to admit a kind of defeat. As I disclosed yesterday, Sir John Gieve is standing down a couple of years early as a deputy governor - which is a faint embarrassment for Gordon Brown, who appointed Gieve in the face of resistance from Mervyn King.

Put all this together and the Bank of England emerges as a more substantial institution. And since King will chair a new Financial Stability Committee which will have the statutory responsibility to prevent the financial system from seizing up or worse, he probably becomes the Capo di tutti Capi for the City.

Here we can perhaps describe the governor as having carried out a 180 degree manoeuvre: he was a cheerleader back in 1997 for New Labour's reform of the bank which promoted its role in monetary policy or the fight against inflation, but more-or-less stripped it of its City leadership role.

Which is also why King, as and when he becomes the guardian of market calm, may need to go on something of a charm offensive at banks and financial firms - because many of them see him as at best aloof and at worst hostile to their interests.

But enough of U-turns, volte faces and mind-changing. In one sense Darling's makeover of the Bank is completing unfinished business.

What I mean is that when the bank's operations in setting interest rates and holding inflation in check became properly professionalised and systematised, the spirit of the gentleman amateur was not wholly purged. In particular, the court of the Bank of England, its governing board, remains a huge and unwieldy body - consisting of assorted grandees from industry, the City and the trade unions.

It will be shrunk and re-stocked with financial technocrats - who will also people the new Financial Stability Committee.

So what's that banging noise? Yes, it's the sound of stable doors slamming shut, long after depositors panicked and hobbled the Rock.

But it's not too little too late. In particular, we would all be able to sleep a bit easier in a few years if the Financial Stability Committee were to establish a partnership with the Financial Services Authority to put an effective brake on silly lending in the next era of market euphoria (yes, there will be another).

Gieve to go

Robert Peston | 19:41 UK time, Wednesday, 18 June 2008


Sir John Gieve is to stand down early as deputy governor of the Bank of England, I have learned.

Sir John GieveHe is in charge of the Bank of England's operations responsible for the stability of the financial system.

Sir John's departure coincides with an initiative by the Treasury to formalise and beef up the bank's financial stability role.

The unexpected announcement will be made tomorrow, when the Treasury is also expected to confirm that Charles Bean - the Bank's chief economist - is to become the other deputy governor in charge of its monetary policy side.

Charles Bean replaces Rachel Lomax.

It is unclear who will replace Gieve. The Bank of England's senior directors would probably wish the new financial stability deputy governor to be Paul Tucker, the bank's executive director in charge of markets.

The Treasury is refusing to comment on the changes.

Gieve was savaged when interrogated last autumn by the Treasury Select Committee for allegedly being insufficiently on top of the crisis at Northern Rock. His colleagues regarded the attack as unfair.

However Gieve is not a markets specialist. And it is thought that the Treasury wants someone with greater technical knowledge in charge of an expanded financial stability division at the bank.

Gieve was appointed deputy governor in January 2006 and has two and a half years of his term to run.

His appointment was pushed through by Gordon Brown, when he was chancellor, in the face of stiff resistance from the Governor, Mervyn King.

Mr King recently had a battle with the Treasury to have his preferred candidate, Charles Bean, appointed as the replacement for Ms Lomax.

Debt and inflation

Robert Peston | 10:19 UK time, Wednesday, 18 June 2008


The legitimacy of the Bank of England's Monetary Policy Committee was never going to be properly established until it was tested by serious economic difficulties - of the kind we're experiencing now.

Bank of EnglandWhich is why I was intrigued by your response to Peter Two-Point-Two's whinge.

Many of the comments sympathised with P 2-P-2. But here's what should cheer up the governor, Mervyn King.

Few of you directed your ire about our economic slowdown at the Bank of England or said that the Monetary Policy Committee should slash interest rates and to hell with the inflationary consequences.

I'll admit to being slightly surprised, because many of those saddled with the biggest debts are also too young to have lived in a Britain racked by endemic inflation. These young Micawbers ought to be able to grasp that inflation bails out those who have borrowed too much, while not having had first hand experience of the damage that would be wreaked to the wider economy.

It's also slightly surprising that neither the government nor the governor have recently felt the need to re-state the case against inflation in a populist way, now that the evil is upon us again - even though there is a vast younger generation that only know of it from folklore and story books.

Gordon Brown and Alistair DarlingInstead the Chancellor, Alistair Darling, and the Prime Minister, Gordon Brown are trying to slay the dragon, by "leading" a putative global initiative to curb price rises in oil and food - though many analysts see them as using a toy plastic sword against an indomitable force of nature.

By the way, I can't commend too highly Nick Robinson's note on Brown's intervention in the oil market. Some would say that the mismatch between the prime minister's ambition to squeeze out the oil speculators and his modus operandi may be Pooteresque.

Better, perhaps, for Brown and King to be out there explaining in detail why we dare not risk a spiral of inflationary wage increases, which would undermine the ability of both businesses and households to plan and invest in a rational way.

It is, however, a tough sell.

When Darling in his letter to the governor of yesterday was demonstrating the government's anti-inflation intent by swaggering about multi-year pay deals covering 1.5 million public sector employees, he was on dangerous territory: he was, in effect, boasting that many of them had taken a real pay cut, because these deals were agreed before the great oil and food surge.

Darling did go on to say that "inflationary pay settlements would undermine rather than raise people's living standards with a damaging circle (sic) of wage increases eroded by steadily rising prices".

However, if you've borrowed too much, what you want is the value of money to decline - serious inflation is your best hope of avoiding the full and proper consequences of your imprudence.

Inflation is - of course - profoundly unfair to the thrifty, to those who have saved through thick and thin, because their nest eggs are smashed.

So here's what should worry King and Brown, and even David Cameron and George Osborne. The indebtedness of the United Kingdom - the record borrowings of companies and households - means that the political establishment must not take for granted that they have won the argument against inflation once and forever.

One measure will suffice for now: on figures that are now six months out of date and therefore probably understate the problem, companies and individuals are close to paying out record proportions of income to service their debts: the ratio of interest payments to profits for non-financial companies was almost 30% at the end of last year, perilously near to a peak; and households were paying out more of their income in interest and mortgage repayments than they had been doing since 1991, even before the sharp increase in the cost of fixed-rate mortgage deals caused by the credit crunch.

I shall return to the question of where the burden of borrowing is sharpest soonish, because our economic trajectory will probably depend more on the distribution of debt than on the aggregated weight.

But even these crude statistics capture a serious threat. As growing numbers of households and businesses have difficulties meeting their financial obligations, the pressures from them for an allegedly painless and quick inflationary fix will probably intensify.

There could come a moment when there would be widespread popular unrest at the sort of disclosure we had today from the Bank of England, that only one member of the Monetary Policy Committee at the last meeting voted for a cut in interest rates.

The over-borrowed are a sizeable minority of the electorate, so politicians will find it difficult to ignore their agony - though for all our long term prosperity, politicians will probably need to find a way of feeling their pain without actually doing anything very much about it.

Letter to the governor

Robert Peston | 15:22 UK time, Tuesday, 17 June 2008


This is an open letter to the governor of the Bank of England and to the chancellor of the exchequer from Mr Two-Point-Two, a thirty-four-year old school teacher from Anytown, UK.

Dear governor, dear chancellor,

I've read the letters you've sent to each other (pdf links) explaining why inflation is above target and why it's so important that it should be returned to 2% without undue delay. It occurred to me that it might be useful for you to know that I don't recognise the economy you describe, even though I am supposed to live in it.

You could be referring to economic conditions on Mars, not the financial pressures facing our family.

The thrust of your letters appears to be that salaries and wages must, under no circumstances, rise to compensate for the squeeze in living standards precipitated by the recent jumps in fuel, power and food prices.

Mervyn KingThere's a threat from the governor that he will increase interest rates if there are signs that earnings are on the rise. As I understand it, he wants to prevent the increases in fuel, power and food costs feeding through into more generalised price rises, or what economists would call second round inflationary effects.

Mr King is implying that families like mine should grin and bear a fall in our living standards, as a price worth paying for seeing the rate of increase in the consumer price index fall back to its target. The chancellor plainly agrees with him.

But I fear that neither of you can understand quite how much we're being squeezed. If you did, I am sure you would not ask us to make this sacrifice in quite such a matter-of-fact way.

You say that inflation is currently 3.3% and you imply that's a terrible thing. If only you knew! The cost of living has been rising much faster than that in our household.

As a young family with children, our main outgoings are:

1) food - up by 8% over the past year

2) energy - up 10%

3) petrol - up one-fifth

And that's not all. We bought our first house 18 months ago. Our two-year fixed rate mortgage is coming to an end and - from what I can gather - our repayments are likely to rise by more than 25%.

For the past year, we have just about been making ends meet, because my wife works part time in a local shop. But its owners are facing a double squeeze from falling sales and an increase in the cost of credit - and she's been warned that they may not be able to keep her on much longer.

To cut a long story short, we are extremely anxious about the future. And it's not just our spending power that seems to be shrinking before our eyes. All our savings were tied up in our house - and the recent fall in house prices has almost wiped out what little wealth we had.

Also, at the risk of appearing mean-spirited, I can't help but notice that the impact of these economic difficulties seems very unevenly shared.

City workers outside the Bank of EnglandI am not going to repeat the bloomin' obvious about all those millions earned by supposedly brilliant bankers in the City - whom, it turns out, were in part responsible for the credit-crunch part of the mess. Instead I am going to point out that the brunt of the economic storm is being born by those of us trying to make our way in the world, while the older generation seems more sheltered.

Take my parents. Their pensions are protected against inflation, they have paid off their mortgages, they rarely use their car and they have cash on deposit in the bank. So they are feeling pretty content.

I shudder to say it doesn't seem fair or right, but...

Right now I haven't got the time to work out who to blame for what's gone wrong. But before the next election, I intend to find the time.

Yours sincerely,

Peter Two-Point-Two

UPDATE, 04:55PM: I know my parents are thoroughly deserving of financial security in their latter years. But the rapid inflation of the 1970s and 1980s wasn't so terrible for them in one very important way. It meant that the value of their mortgage shrank and shrank and shrank relative to their earnings, which rose and rose and rose. Or to put it another way, inflation massively reduced the burden of their debts. By painful contrast, at a time when the imperative is to kill inflation, I fear that our mortgage will be a millstone around our necks till we peg out.

FSA burns hedge funds

Robert Peston | 10:10 UK time, Friday, 13 June 2008


The Financial Services Authority has this morning burned a few hedge funds and short sellers.

The City watchdog's clampdown on short-selling during rights issues has led to sharp rises in the share prices of HBOS and Johnston Press, both of which are in the middle of the process of raising new capital through rights issues, and of others - including the builders Taylor Woodrow and Barratt - which are thought to have been considering rights issues of their own.

If this doesn't prevent HBOS's £4bn issue of new shares being dumped on its nervous underwriters, nothing will.

But there's a bigger point: if you want evidence not only of the irrationality of markets but of individual market participants, the FSA's squeeze on the hedge funds is it.

As I mentioned in my blog on how short-selling is damaging the financial health of our banks, there was an opportunity here for the big institutions that look after our long-term savings to turn off the tap that allows short-selling - and in the process of turning off that tap, to help themselves and their clients.

Hedge funds that short-sell shares depend on their ability to borrow the relevant shares from giant insurers and pension funds (short-selling is selling stock you don't own, in the expectation that the price will fall and you will be able to buy the stock back for less than what you sold it for).

But although the giant insurers and pension-fund groups receive a fee for lending shares, they and their clients are damaged by the short-selling facilitated by the lending - in that during a time of market hysteria, of the sort that exists right now, a fall in a company's share price caused by short-selling can lead to a significant increase in its cost of capital, which can do it permanent damage.

In other words, the process of lending shares by a pension fund or insurer can lead to a permanent fall in the value of those shares, to the detriment of the pension fund or insurer - and more germanely to the detriment of their clients (that's you and me, by the way, or those of us saving for our retirement).

Which is why the FSA spoke to the big pension funds and insurers and suggested that the best way to curb the worst excesses of short-selling would be if they voluntarily stopped lending the stock.

And what's extraordinary is that these big institutions refused to do so.

That's quite shocking. It makes them look short-termist and thick.

There's a reputational issue here for their trade bodies, the Association of British Insurers and the National Association of Pension Funds.

Perhaps they should now put in place their own code of practice to restrict stock lending during a rights issue - because surely it would be more of an indignity to have that forced on them by the FSA, as it implies this morning that it will do.

More pressing perhaps is a serious financial issue for a number of hedge funds.

The FSA has announced that they have precisely a week to reduce their short positions to less than one quarter of a percentage point in companies that are trying to raise capital with a rights issue.

If they don't, their shorts will be disclosed for all to see - and they'll be vulnerable to attempts by other hedge funds to push up a relevant company's share price and thus generate losses for competitors with short positions.

If the short-selling hedge funds are mashed in what might be described as bull raids, they're unlikely to attract much sympathy.

Rate shock

Robert Peston | 16:50 UK time, Monday, 9 June 2008


Short-term UK interest rates surged by an almost unprecedented amount today - by between 0.3 and 0.4 of a percentage point depending on maturity and instrument.

How can this be at a time of economic slowdown? Well it's all about surging inflationary pressures - from rising energy and food prices - and the expectation that the Bank of England is more likely to raise interest rates than cut them in the coming months.

The trigger today was those quite dreadful stats on the increase in what manufacturers are paying for materials and what they are charging for their products - coupled with the delayed effect of last Friday's remarkable jump in the oil price.

What does it mean? Well it presages further rises in mortgage rates, since the most popular fixed rates are linked to the so-called two year swap rate, which rose by 0.3 of a percentage point today.

Perhaps the best that can be said of today's interest rate surge is that the markets are doing the work of the Bank of England for it, without the need for the MPC to come off the fence and actually raise the policy rate - as and when mortgage rates rise further, homeowners will become even more lugubrious, consumer spending will be squeezed even more, and perhaps some of the inflationary pressures won't materialise as actual increases in consumer price inflation.

But these are microscopic crumbs of comfort. With every hour that passes, the manic depressives who have been warning of a return to an era of stagflation - a growthless world of rising prices - seem more and more sane.

Rock's rocky valuation

Robert Peston | 06:59 UK time, Saturday, 7 June 2008


The spec for a reputation-testing, privacy-shattering, job-from-hell was published this week on the Treasury's website.

It's the official advertisement for the job of determining compensation for some 200,000 former investors in Northern Rock, whose shares were expropriated when the bank was nationalised in February.

Putting a fair value on the shares should be an intellectual challenge, given that there's never really been a financial debacle quite like the run on the Rock.

But that's not why the main qualification to be official valuer of Rock stock is probably a strong masochistic bent, along with the formal requirement to have proven professional skills in company valuation.

The thing is that although the Treasury insists it wants someone demonstrably independent from Government, it's also sent an unambiguous message about the result it wants from the valuation.

The Treasury has a strong conviction that the shares are worth nothing, give or take a farthing or two, and has enshrined this conviction in the mandate for the valuer.

That mandate says the shares have to be valued on the hypothetical basis that it's not a going concern, that it had been put into administration under insolvency procedures and that the Treasury and Bank of England had withdrawn all financial support from the bank.

On those fictional assumptions, the Rock would have a massive funding gap. There would be a fire sale of assets at a knockdown price. And there would almost certainly be a massive deficit on reserves.

All of which would put a price on the shares of zero.

So far, so straightforward.

Some might argue that the valuation has been rigged, but it looks like a pretty easy job.

The problem is that the 200,000 former Rock shareholders - including a couple of feisty hedge funds and a leading insurer - regard the valuation mandate as state-sanctioned theft.

They have begun legal proceedings to secure what they would perceive as a fairer basis for valuation.

The shareholders believe that the shares are worth at least the value of net assets in the company's balance sheet - which even after the mayhem of the autumn was still £1.7bn at the turn of the year.

So anyone signing up to be the valuer would probably make instant enemies of an angry mob of City institutions and thousands of Geordies who saw their Rock shares as a nest egg.

No wonder the Treasury is insisting the successful applicant should take out "an appropriate level of professional indemnity insurance".

It's not, therefore, a sinecure - and there is unlikely to be a deluge of credible applications by the closing date of July 4th, although the Treasury says that interest in the post is rather greater than commonsense might suggest.

Is there any chance of the Treasury changing the spec to allow a valuer to set the terms for the valuation in an independent way?

That's unlikely because the stakes are just too high.

The Treasury doesn't have £1.7bn going spare.

It recoils at the idea of paying off the hedge funds, which built up their stakes only after the crisis at the Rock had begun.

And, most important, it's a principle for the Treasury, the Bank of England and the Financial Services Authority that when a bank runs into difficulties and has to be rescued by the injection of taxpayer-backed loans, the shareholders should suffer pain and punishment.

Bailing out shareholders, they fear, would remove the incentive for the owners of other banks to ensure their institutions are run properly and avoid the Rock's fate.

The credit insurance rip-off

Robert Peston | 11:31 UK time, Thursday, 5 June 2008


A culture in our banks of taking unfair advantage of ill-informed and unconfident borrowers has been exposed by the Competition Commission.

Credit cardOur biggest banks can take no pride in the provisional findings of the Commission's review of the sale of credit insurance to cover the risks that we won't be able to keep up payments on personal loans, credit-card debt and mortgages.

That said, I have doubts about the way that the Commission has equated profit in excess of cost of capital with overcharging - and on that basis says consumers are being ripped off to the painful tune of more than £1.4bn.

But the evidence is clear. Competition in the market for "payment protection insurance" is inadequate. And the distributors of this stuff are making excessive profits from it.

It is absurd that in two-thirds of personal loans covered by this insurance, the annual cost for the consumer of the insurance is the same or greater than the cost of servicing the debt.

That implies either that the banks are making no provision for the risk of default when setting the interest rate, which seems unlikely. Or the cost of the insurance is wholly disproportionate to the risks it is supposed to cover.

The Commission is careful not to make allegations that particular banks are sharper operators than others.

But it does point out that the distributors with the largest share of this market are Lloyds TSB, Barclays and HBOS.

So should we just say hooray and assume that consumers can look forward to a better deal?

I would be slightly cautious about the consequences for borrowers.

The Commission has come up with a series of possible remedies, whose aim would be to generate proper competition in the provision of this insurance that would drive down prices.

It has even mooted a temporary price cap.

However there is bound to be an element of cross-subsidy between the excessive profits banks charge for this insurance and what they charge for personal loans and mortgages.

Removing that cross-subsidy could lead banks to increase the explicit costs of credit.

Note also that in our decelerating economy the risk of lending for banks has risen - and they are already charging most of us more for loans.

So something has got to give, on the assumption that the Competition Commission succeeds in slashing what the banks receive from insuring us against the risk of default at a time when the risk of default is rising fast.

That something would either be a further sharp contraction in the amount of credit banks make available or a further sharp rise in the interest and other charges on what little credit is offered.


Bradford revisited

Robert Peston | 13:48 UK time, Wednesday, 4 June 2008


The insurers and pension funds may be revolting. A number have contacted me to express concerns that the £179m being paid by the private equity giant Texas Pacific for a 23% stake in Bradford & Bingley is far too little - that the deal is a steal.

Bradford & Bingley branchWell the terms of the sale are certainly unusual. What is most unusual is that TPG has been offered the opportunity to buy its holding at well below the prevailing market price.

TPG would pay 55p a share - which even now, after the rout in B&B's shares, is a hefty discount to the market price of 67.5p.

I simply can't remember the last time that a substantial British company sold a significant stake in itself at a discount of that magnitude.

And the very important point is that, as a matter of pure theory, when a company sells shares at less than the prevailing market price to an outside investor, its existing shareholders are impoverished - they end up with a lesser or diluted stake in that company's assets.

In this case, the dilution would be huge: B&B had shareholders' funds of £1.2bn at the end of December, but these are being valued at just £378m at the subscription price offered to TPG.

The value of B&B's net assets have fallen a bit since then. And some adjustment has to be made for other shares that are being issued. But arguably TPG is being given the opportunity to buy pound coins for about 68p each.

For the avoidance of doubt, it may be your pound coins that are being sold for less than face value - in that your pension pot may well be invested in Bradford & Bingley shares, whether you know it or not.

That is why big British pension funds and insurers have made it crystal clear to all British companies that they are never to sell shares at a discount to outsiders, unless they are in the direst of straits.

So just how dire was it for B&B last weekend when it was negotiating the cash injection with TPG?

Well, pretty dire.

It had discovered that profits for the year would be worse than it or the market had been expecting. And that a sharply rising proportion of borrowers of its buy-to-let and self-certified mortgages were experiencing repayment difficulties.

That raised worrying questions about the bank's internal financial controls - which was bound to undermine City confidence in its executives.

But the City was not given the opportunity to assess whether the chief executive, Steve Crawshaw, was still up to the job - because at the same time as the financial merde was hitting the fan, he was diagnosed with a serious cardiovascular illness and quit.

The third whammy was that the profit warning might well have derailed Bradford & Bingley's attempt to raise £300m in a conventional rights issue.

In other words, Bradford & Bingley was staring into the abyss. Its directors were bracing themselves to tell the market that profits were heading south, that mortgages were going bad, that it had a lost a chief executive, and that it was uncertain whether it would be able to raise the capital it had said it needed.

For the avoidance of doubt, none of this meant it was bust. It retained significant capital.

But in these times of high anxiety, the Treasury, the Bank of England and the Financial Services Authority all became extremely concerned about the possible consequences of announcing that quite so many things had gone wrong for Bradford & Bingley.

They were worried that Bradford & Bingley would lose the confidence of depositors and other creditors.

There was a fear that the Northern Rock debacle of last autumn - a retail and a wholesale run - could be repeated.

So it was a fully fledged crisis at Bradford & Bingley.

And in that sense, the injection of funds from TPG was a rescue: it represented a very important vote of confidence in B&B by an investor of worldwide renown.

That's why the private equity group could dictate its terms.

But note well.

TPG has not yet subscribed the £179m of cash it has promised.

If existing investors in Bradford & Bingley think they are being short-changed, they have a few days to offer the bank a bit more than £179m.

It could be rational for a handful of pension funds and insurers to club together and find a couple of hundred million quid to trump TPG. Or one of these conventional institutions on its own could break the habits of a lifetime and manifest the cojones to do the kind of deal that has made fortunes for private equity firms and hedge funds.

Short-selling banks

Robert Peston | 10:15 UK time, Tuesday, 3 June 2008


Short-selling of shares is one of those City activities that generates a vast amount of emotion.

Canary Wharf towerQuite a lot of people, including senior people in business, regard the practice of selling shares, securities and commodities you don't own as immoral, as a form of heinous speculation.

I don't take that view.

On the whole, I regard short-sellers as making a helpful contribution to the process of setting fair prices for tradable securities and commodities.

When shares, for example, are priced at euphorically high levels, that is just as likely to lead to a serious misallocation of capital resources as when shares are priced below fair value.

So when a hedge fund such as the short-selling specialist Kynikos identified the fraudulently managed US energy giant, Enron, as grotesquely over-valued, and then sold the shares short, that was a public service (albeit one for which Kynikos's founder, Jim Chanos, was handsomely rewarded).

And although some gag at the billions trousered by the US hedge-fund superstar John Paulson from short-selling securities linked to US subprime, is it reasonable to criticise him for profiting from banks' and other hedge funds' stupidity at overvaluing these securities in the first place?

But short-selling isn't always a blameless and harmless activity.

At times like these, when uncertainty about the robustness of the financial system verges on hysteria, short-selling can cause damage to the health of real businesses - with serious ramifications for their respective employees and customers.

Take the case of a bank that needs to raise capital. And there are quite a few of those around the place right now.

When the share price of that bank falls, it becomes much harder and more expensive for that bank to raise the capital it needs.

And that in turn reinforces the downward momentum to the share price, because the prospects for that bank worsen as the cost of capital rises.

What's worse for the bank, the fall in its share price can also spook providers of credit and depositors - which, again, can do serious damage to the bank's profitability and even (in a worst case) its viability.

So short-selling a bank perceived to be vulnerable looks like a one-way bet for hedge funds, a sure thing.

I am not going to hold up Bradford & Bingley as an example of the excesses of short-selling hedge funds, because the worrying rise in arrears on buy-to-let and self-cert mortgages indicates that the short-sellers were probably right to identify it as over-valued.

But it's less clear that the astonishing falls in the prices of HBOS and Royal Bank of Scotland - which are trying to raise humungous sums in rights issues of new shares - are merited rather than the self-fuelling consequences of a dangerous short-selling feedback loop.

So should short-selling be restricted or banned?

That's quite difficult to do in a financial world where shares, securities and commodities can be traded across borders.

But even without the intervention of government or regulators, the owners of these banks - the big institutional investors who manage the long-term savings of millions of us - could more-or-less put a stop to short-selling.

And it's rather astonishing that they haven't put a stop to it.

Most giant pension funds and insurers have to own a bit of HBOS or Royal Bank, for example, because at least part of their funds will track the UK market - and that means owning a slice of our banks.

And if the real business prospects of HBOS or Royal Bank were damaged by the impact on creditors' confidence of a falling share price, well that would do serious damage to the health and wealth of the pension funds and insurers that own their shares.

Here's the important point.

Short-sellers have to borrow shares in order to sell them - and they borrow them from pension funds and insurers.

In a hypothetical case, a hedge fund would borrow a million shares in Megabank for a fee (in effect an interest rate).

It would then sell those million shares at the prevailing market price of £8 a share, raising £8m in total.

What the hedge fund hopes is that Megabank's share price would then slide.

Let's say it does - to £4 a share. The hedge fund then buys a million shares for £4m and hands the million shares back to the lender.

Which means that the clever-clogs hedge fund has banked a real cash profit of £4m. Nice work.

But note that the hedge fund would be up the creak without a paddle if it was unable to borrow the shares in the first place.

Isn't it slightly odd that insurers and pension funds actually facilitate short-selling by hedge funds?

Surely it would be rational for them to stop lending stock to hedge funds, since in the very act of lending to them they may be undermining the value of the shares they own.

It does seem the height of madness that institutional investors, which are obliged to own shares in the likes of RBS and HBOS for years and years, may be encouraging falls in the share prices of RBS and HBOS and possibly even damaging the long-term prospects of those banks.

Naturally we rang our leading insurers and pension funds to ask whether they were lending out shares in RBS, HBOS and Bradford & Bingley, but mostly the response was a sheepish "no comment".

But I haven't heard back yet from Insight, the fund management arm of HBOS itself.

Can HBOS itself really be encouraging short-selling of the sort that mullered its stock?

I'll let you know, when I know.

UPDATE: Here's the answer from HBOS: it doesn't engage in much stock lending, by virtue of the structure of its fund management business, rather than as a matter of policy.

B&B's rising arrears

Robert Peston | 08:59 UK time, Monday, 2 June 2008


Bradford & Bingley's shares have dropped sharply again this morning following its warning of worsening arrears on the buy-to-let mortgages it provides.

Bradford & BingleyIt blames the problems experienced by its borrowers on worsening economic conditions which have led to house price deflation.

The value of its buy-to-let mortgages where borrowers are either more than three months behind with payments or the properties have been repossessed has jumped from £828m at 31 December to £1.1bn at 30 April.

Other bad news is that the profit margin on its lending remains under pressure - because, like all banks, the cost of raising money for Bradford & Bingley remains high.

And it has suffered further charges on its so-called structured finance portfolio, or its foolish investments linked to US subprime.

Putting this altogether means that for the first four months of 2008 Bradford & Bingley made a loss of £8m - far worse than the City had been expecting.

But the City watchdog, the Financial Services Authority, believes the pain will be restricted to shareholders - and there is nothing to alarm those with savings in the bank.

Even for shareholders there is some good news - with the announcement that the renowned private equity investor, Texas Pacific Group, is paying £179m for a 23% stake in Bradford & Bingley.

Although TPG is only paying 55p per share for this stake - around 90% below Bradford & Bingley's share price in 2006, the housing market's year of unsustainable bliss.

UPDATE 09:26: Other British banks are jumpy this morning, having seen B&B slip on its banana skin.

Royal Bank, which hopes to avoid the humiliation of seeing its rights-issue shares fall into the hands of underwriters, has put out a statement that its UK buy-to-let mortgages represent only 1% of its UK loan portfolio and that there has been no deterioration in its trading performance since its last statement on April 22.

It is shouting at investors that they shouldn't assume that B&B's difficulties are a harbinger of horrors at RBS - although RBS's share price has this morning slipped just a little bit nearer that fateful rights price.

Private equity shores up B&B

Robert Peston | 21:59 UK time, Sunday, 1 June 2008


One of the world's largest private equity houses, Texas Pacific Group, is to take a stake of around 20% in Bradford & Bingley, to shore up the finances of the leading buy-to-let mortgage lender.

Under a radical reconstruction of the bank's existing plans to raise capital through a rights issue of new shares, TPG would inject around £150m of new funds into B&B.

B&B's existing shareholders would be asked to provide a further £250m of new capital.

That represents a scaling back of the right issue from the £300m investors are currently being asked to inject. But B&B would end up raising more than it had hitherto planned to do, around £400m in total, thanks to the contribution of TPG.

The price of the new shares for TPG and for B&B's existing shareholders is expected to be a bit above 50p per share, well below the original rights price of 82p per share.

B&B has had to reconstruct and recalibrate its rights issue of new shares because it has come to the humiliating conclusion that its pre-tax profits this year will be significantly less than the City had been expecting.

It will tomorrow announce that its profits in 2008 will be "materially less" than analysts' forecasts of about £250m.

B&B will not put out a formal new profit forecast, but analysts are likely to revise their forecasts down to around £150m.

However TPG has a fearsome track record as an investor. And the news that it is taking a substantial stake in B&B may reassure the stock market that the worst could be behind B&B.

The lenders' profits have been hit by a rise in the number of its borrowers who are experiencing difficulties making repayments on mortgages.

A further squeeze on profits has come from a narrowing in the gap between the interest rate it pays for funds and the rate it receives from borrowers.

B&B has had a torrid time since the onset of the credit crunch last autumn, and its share price has fallen by more than two thirds in just the last six months.

It has been monitored closely by the Financial Services Authority, the City watchdog, the Bank of England and the Treasury for months, ever since Northern Rock asked for an emergency loan from the Bank of England last September.

However, according to bankers and regulators, B&B's troubles are not comparable in gravity or complexity to those of Northern Rock.

The Financial Services Authority has in the past couple of days been "all over B&B like a rash" to assure itself that the bank's depositors have nothing to fear, according to a banker.

A regulator also told me that, unlike Northern Rock last September, B&B's is not suffering from a shortage of liquid funds that would imperil its future.

He added that its balance sheet was not particularly weak, even without the injection of new capital.

B&B's problem is that the housing market downturn has knocked the profits it makes from providing buy-to-let mortgages. "It has a trading problem, not a funding problem", said a banker.

He added that the outlook for buy-to-lets was uncertain, which is why it makes sense for B&B to raise additional capital.

B&B today announced that its chief executive would step down due to ill-health with immediate effect. Pending the recruitment of a replacement, B&B will be run by its chairman, Rod Kent, who is best known in the City for building up the merchant bank Close Brothers over many years.

Kent may also make further senior management changes.

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