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Archives for September 2008

Why our banks are vulnerable

Robert Peston | 09:22 UK time, Tuesday, 30 September 2008


The most important markets announcement this morning is that the Irish government has placed an unlimited two-year guarantee on all deposits and some debt in six Irish banks, to "safeguard the Irish financial system".

The emergency measure follows an extraordinary 26% fall in Irish bank shares yesterday.

This has huge ramifications for us.

Potentially it puts British banks at a massive competitive disadvantage - especially since other European governments are also taking urgent steps to reassure their citizens that their bank deposits are safe.

There is a widespread perception that the £35,000 limit to deposit protection in the UK, and the proposed increase to £50,000, are inadequate - and that the absence of full protection makes our banks more at risk of a run on retail deposits.

That has two damaging effects.

It spooks giant global money managers and providers of wholesale funding - and if they were to accelerate their withdrawal of cash from UK banks, well we'd see a domino-effect of horrible banking failures.

Second, it undermines the confidence of investors in our banks shares - which is why their share prices have become so vulnerable to sharp falls.

So top of the list of what this government could do to limit the damage to us from Washington's bail-out bungle would be to announce with immediate effect that all deposits in UK banks are 100% guaranteed by the government.

The chancellor did this after the run on Northern Rock last September.

There's a powerful argument that he should do it again.

PS. There is also a perception that our banks remain at a disadvantage compared with those in the eurozone and the US in respect of the assets they can swap for central bank loans.

Although the Bank of England has, over recent months, widened the collateral it will take in exchange for loans, there is a perception (which is as important as the reality in a climate of hysteria) that it is less amenable in the way it provides financial support than either the European Central Bank or the Federal Reserve.

This is something that the Bank of England can and should probably address, fairly speedily, if it wants to shore up the confidence of money markets in the robustness of our banks.

Catastrophic system failure

Robert Peston | 07:44 UK time, Tuesday, 30 September 2008


"We've got to sit, wait and hope."

That sentiment was expressed to me in the past 12 hours by bankers, fund managers, regulators and politicians.

What it reflects is a sense of powerless to direct events in global markets, following the rejection by the US House of Representatives of the Whitehouse's $700bn plan to extract poison from US banks.

Traders at the New York stock exchangeThere are two big fears driving markets: first that the risk of a serious recession in the US and in Europe has risen sharply; second, and more immediately, that the danger of a domino-effect collapse of a series of financial firms is also much more real than it was.

Both of these anxieties has prompted a massive reallocation of investors' cash, away from shares perceived as risky and commodities that are vulnerable to lower global demand as economies slow.

US government bonds, gold and investments perceived as - well - solid gold have soared.

These are the sort of conditions that can kill hedge funds for example, as the value of their investments suffer from violent swings and their backers ask for their money back.

You may not weep for them, but if they're forced to liquidate in a hurry - well that would force down prices of their investments in a way that would damage other financial firms.
In this climate of sheer anxiety, the normal levers pulled by central banks and governments aren't very effective.

Extraordinary quantities of loans have been provided by central banks to commercial banks - but it hasn't made the banks much more willing to lend to each other.

Central banks could cut interest rates - but these rate cuts may not actually be passed on to any great degree in the interest rates the banks charge each other or us.

What's needed is some sign that the White House and Congress do have the ability to mend ailing US banks.

At the moment, it's the breakdown in the US political system that's doing as much damage as the breakdown in its banking system.

The day the bill arrived

Robert Peston | 14:30 UK time, Monday, 29 September 2008


Since the onset of the credit crunch in August of last year, there have been bad days, worse days and today.

What a horrible coincidence of accidents and emergency resuscitations we've seen.

Here they are, in no particular order.

1) The collapse and nationalisation of Bradford & Bingley, set to cost our cash-strapped banks at least £9bn over the coming years (see my notes of this morning).
2) The injection into Fortis, a continental bank rather bigger on one measure than the Belgian economy, of £9bn of Benelux taxpayers' cash.
3) The takeover, with US taxpayer support, of Wachovia - the huge battered US retail bank - by Citigroup, a bank which has had capital-deficiency problems of its own.
4) A massive penny dropping on Wall Street, the recognition that Congress will extract back from financial firms in a few years the $700bn to be injected into banks to keep them alive.

It's the day when no-one could be under any illusion about the costs of rebuilding our structurally impaired financial system.

That cost will fall directly on taxpayers and on banks.

Indirectly it will hurt businesses - some of which are already being starved of vital capital by banks' inability to lend.

And for millions of people in the US and Europe, there's the double blow of an erosion in the value of their wealth (through declining property prices and the falling value of long term savings in pension funds) and of an increased risk of redundancy.

Or to put it another way, for most of us, there's little in the way of shelter from the storm.

Don't forget that last week we had a massive injection of one-week loans into the banking system by the Federal Reserve and Europe's troika of leading central banks. And in the UK, the Bank of England auctioned £40bn of three-month loans.

That was supposed to calm nerves and reduce the price of money for banks.

But the cost for banks of borrowing from each for three months in sterling, euros or dollars has risen again.

Banks are as worried as they've ever been about the credit-worthiness of their peers. Trust and confidence are almost extinct qualities.

Share prices too are falling hard - which in part is a belated recognition that the crisis in money markets will have an impact on the prospects for most companies.

If economic growth was going to be slow before the events of the past three weeks, it's going to be a lot worse now.

And if you wish to know which economies are perceived by global investors to be most flawed and vulnerable, you could do worse than look at the price of insuring sovereign debt in the credit default swap market.

Those CDS prices tell you that Austria, Belgium, Denmark, Finland, France, Germany, Sweden, and the Netherlands are all perceived to be more credit-worthy - to be in a better position to service their national debt - than either the US or the UK.

PS. Silly me. In my list of financial firms in receipt of massive first aid, I forgot to mention Germany's Hypo Real Estate, the commercial property lender, which has received a whopping £28bn in credit guarantees from the German government in collaboration with a consortium of banks.

Oh, and Iceland's third largest bank, Glitnir, has been nationalised.

B&B collapse to cost City £9bn

Robert Peston | 11:14 UK time, Monday, 29 September 2008


Best estimates by officials at the Financial Services Compensation Scheme is that the collapse of Bradford & Bingley will cost our banks up to £7bn, in respect of what they'll ultimately have to pay into the Scheme to make good future losses at the nationalised bank.

Branch of Bradford & Bingley_203pa.jpgAlthough that won't be payable till 2011, there will be interest costs for the banks on the loan being made by the Treasury to cover what's owed to B&B's retail depositors.

Those interest costs will begin with a payment of £450m next September, which will represent about six months of interest. The interest will then be payable annually on whatever balance is drawn down.

The total aggregate interest costs will be well over a billion pounds over the life of the loan, probably nearer to £2bn or even £3bn (I may be understating this cost - it all depends on how quickly the loan is repaid from the run-off of B&B's mortgage book).

So the costs to our banks of the collapse of Bradford & Bingley are likely to be somewhere in the region of £9bn to £10bn - a colossal cost to the City for the sins of B&B.

What's more, those costs will fall disproportionately on our biggest banks, namely Royal Bank of Scotland, HSBC, Santander, Lloyds TSB and Barclays - because contributions to the Financial Services Compensation Scheme are divvied up on a pro rata basis, measured by share of insured deposits (in other words, banks which take in more cash from retail savers and depositors pay more to the Scheme).

All of which begs a big question: why on earth didn't those big banks club together to rescue B&B rather than let it collapse and be nationalised.

Surely that would have been cheaper for them.

Their apparent inability to act collectively for their common good is not altogether encouraging.

City pays for Bradford & Bingley

Robert Peston | 08:15 UK time, Monday, 29 September 2008


The most politically explosive aspect of Bradford and Bingley's nationalisation is how much risk of losses is being foisted on taxpayers.

Branch of Bradford and BingleyThe answer, surprisingly, is not much.

Because the bulk of any future losses will be born first by shareholders and providers of what's called subordinated debt

And after that losses - up to a staggering £14bn - would fall on the banking industry.

For taxpayers to lose a penny Bradford and Bingley's future losses would have to be unthinkably huge.

The reason taxpayers are protected is that on Saturday the board of the Finanacial Services Authority ruled that B&B was unable to pass the test of being a viable bank, and therefore a claim was triggered on the insurance scheme for bank depositors, the Financial Services Compensation Scheme.

That claim would amount to £14bn and is a liability of the banking industry

However the Treasury has decided instead to lend £20bn so that depositors won't lose a penny.

And will only demand repayment from the other banks of any portion of that £20bn that isn't covered by the liquidation of Bradford & Bingley's loan book over the coming few years.

Not all of B&B's loans and assets are available to meet this claim. There are about £25bn available, to repay the £20bn (the rest of B&B's mortgages are pledged to holders of covered bonds and asset-backed securities).

But there is one immediate cost for the banking industry - it will pay the £450m interest cost of the Treasury's £20bn loan.

Santander to B&B rescue

Robert Peston | 21:59 UK time, Sunday, 28 September 2008


I have learned that Santander, the giant Spanish bank that recently acquired Alliance & Leicester and also own Abbey, is likely to acquire Bradford & Bingley's savings business - which looks after £20bn of savings for 2.6m customers.

Treasury officials and bankers are dotting the i's and crossing the t's as I write.

An announcment is expected first thing tomorrow morning - which will also confirm that B&B's £50bn in mortgages and loans is being nationalised.

B&B: end of an era

Robert Peston | 10:20 UK time, Sunday, 28 September 2008


The reverberations from the nationalisation of Bradford & Bingley (see my note of last night for more on this) will be profound.

First, it takes out of the market the leading provider of buy-to-let and self-cert mortgages.

Once the £41bn of B&B's mortgages is publicly owned, it will be run down over the coming years.

And it's very unlikely that the government will feel it wants to use taxpayers money to provide new buy-to-let and self-cert mortgages.

In other words, two big chunks of the mortgage market will be all-but closed - since few other banks are remotely interested in providing this kind of mortgage, which are perceived as higher risk.

That will add to the downward pressure on house prices - and may be a source of anxiety to buy-to-let investors who may have difficulty refinancing their mortgages as and when they need to do so.

Second, the nationalisation will be seen as proof that the demutualisation of building societies - which began when Abbey National became a bank in 1989 - has been a colossal failure for both the former building societies and the British economy.

These specialist mortgage lenders were under such pressure to grow their profits, as public companies, that they became reckless adventurers in wholesale funding markets.

They raised too much money too cheaply on the global money markets, which they then lent too cheaply to British homebuyers.

Which then stoked up the housing bubble. And the popping of that bubble has done for them.

Every single demutualised building society has either collapsed and had to be rescued or has been swallowed up by a bigger bank.

Just this year we've seen the Rock taken into public ownership and HBOS, owner of the Halifax, bought by Lloyds TSB in a rescue takeover.

Abbey itself was taken over in 2004 by Santander of Spain largely because it was hobbled by unfortunate forays into clever-clever financial trading.

The conversion of building societies into banks is an instance where deregulation and the liberalisation of an industry appears to have been an unmitigated disaster.

The Nationwide, which refused to follow the trend, looks smart.

Finally, there is just a chance that the nationalisation of B&B will be the last serious crisis for a UK banking institution.


Well the debacles at Northern Rock, HBOS and B&B all stemmed from their excessive dependence on the UK housing market and on sources of wholesale funding that were vulnerable to disappearing.

Our remaining big banks have much more diverse businesses, so even though they will suffer as the housing market falls, they can generate profits elsewhere to compensate.

Also they have more diverse sources of funding, they are less dependent on the whims of money managers who can shift billions of dollars at the click of a mouse.

In that sense, the nationalisation of B&B and of the Rock are the British equivalent of America's $700bn banking bailout plan.

Their nationalisation - and the rescue takeover of HBOS - removes from the UK commercial banking sector its biggest source of vulnerability.

That vulnerability was the Rock's, B&B's and HBOS's excessive exposure to mortgages that are expected to be a big source of future losses.

B&B to be nationalised

Robert Peston | 21:41 UK time, Saturday, 27 September 2008


I have learned tonight that the Treasury has taken a decision to nationalise Bradford & Bingley, using the special legislation it put through when it took Northern Rock into public ownership earlier this year.

The nationalisation, which could be announced tomorrow night or first thing Monday morning, underlines the scale of the global banking crisis.

However the Treasury will almost instantaneously sell to a bank - or even a number of banks - Bradford & Bingley's 200 branches and its savings business.

So B&B savers, who had more than £20bn deposited in the bank just a few weeks ago, will find themselves customers of another bank.

The Treasury and the Financial Services Authority will spend tomorrow negotiating with banks interested in buying these parts of B&B. These possible buyers included Santander of Spain, HSBC and Barclays.

By contrast, B&B's £50bn of loans - including £41bn of residential mortgages - will not be sold and will be nationalised on a long term basis.

Because of the downturn in the British housing market, it would be impossible to sell these now for anything but a cripplingly low price.

It is possible that these mortgages will be given to the nationalised Northern Rock to manage.

The nationalisation and break up of Bradford & Bingley will represent a momentous event in the history of British banking, because it will mean that every building society that floated on the stock market in the wave of demutualisations of the past two decades will either have collapsed or been sold to a conventional bank.

It may well be seen as proving that demutualisation of building societies has been a colossal mistake, both for the institutions themselves and for the British economy (I will return to this theme in the coming days).

B&B experienced significant withdrawals of cash from its branches and its online bank today, because of customers' concerns about the health of the bank.

However there were no significant queues, except for at four branches before doors opened, because hundreds of B&B staff gave up their day off and volunteered to man the tills.

The Treasury's decision to sell B&B's savings business means that retail depositors and savers should not lose a penny.

B&B's shareholders and holders of its subordinated debt may not be so fortunate.

The Treasury and the Financial Services Authority decided they had to act to nationalise B&B because the bank was perilously close to seeing a demand from investors for the return of billions of pounds - which it would have been unable to find.

The reason it faced this calamitous threat was because credit rating agencies had been downgrading the rating of its covered bonds, a form of funding which involves packaging up mortgages for sale to investors.

It only required one more downgrade, according to a banker, for those investors to be able to demand their cash back. With wholesale funding markets in a state of seizure, it would have been impossible for B&B to borrow more billions to pay off these covered bonds.

B&B: taxpayers on hook for £40bn

Robert Peston | 16:22 UK time, Saturday, 27 September 2008


Santander, the giant Spanish bank that owns Abbey and Alliance & Leicester, may end up owning a chunk of Bradford & Bingley, such as its branches and savings business - because it's been looking at the business (not with any great enthusiasm) for a while now.

The ambitous Spanish bank may know B&B a bit better than some of the other banks being sounded out by the authorities as participants in a rescue, and may be in a position to sign up quicker to a deal.

But the important point is that the Treasury will be unable to do any rescue of B&B that doesn't include taxpayers becoming financially exposed to between £40bn and £50bn of B&B's loans.

Here's why.

B&B's total assets are £50bn, including £41bn of residential mortgages made by B&B, some commercial property loans and other investments.

The mortgages, in particular, are simply unsellable in the current climate of pessimism about the outlook for the UK housing market.

There remain several permutations of what could happen to B&B. It does have some attractive sellable stuff, such as savers with £20bn plus of deposits and the branches.

As I mentioned, these could be hived off and sold (to Santander or another substantial bank).

The big question is what will happen to B&B's £41bn of buy-to-let and self-cert mortgages.

These are B&B's millstone, because of two fears fears:

1) that self-cert borrowers will have growing difficulties keeping up the payments;

2) that increasing numbers of buy-to-let borrowers will hand back their keys, and stop making the payments, as and when the value of their properties sinks below the value of their respectived mortgage debts.

No private-sector bank will take on these mortgages in the current climate of uncertainty without protection from the Treasury - in other words from taxpayers - against potential future losses.

There are only two realistic choices for the Treasury.

It could pass the mortgages on to a private bank, but provide some form of insurance to the purchaser against future losses.

Or it could opt for the cleaner solution, of keeping all these mortgages in the public sector - and perhaps inject them into Northern Rock - in the hope that over time they will in fact yield a profit.

When markets are in mayhem, as they are right now, the Treasury has a luxury unavailable to the private sector: it can take the long view.

If the Treasury took B&B's mortgages directly on to the public-sector balance sheet, it would not have to worry too much about short term cash flow or profits.

It could simply sit and wait for as many years as necessary for market conditions to improve so that the portfolio of loans could be sold back to the private sector.

Or it could wait even longer for most of the borrowers to repay, so that the loans simply run off.

The big point is that for an owner with the resources to sit out the downturn in the housing market, B&B's mortgage book should at least break even and could even generate gains.

Only the public sector, that's us as taxpayers, is able right now to invest through this horrible housing-market

PS Well done to B&B and its staff today. I am told that hundreds of staff volunteered to come into the branches to handle the anticipated demand from customers for information on what's going on and for their savings.

As a result, there were queues in just four branches.

How will B&B be rescued?

Robert Peston | 08:17 UK time, Saturday, 27 September 2008


The position on B&B this morning remains as per my note of yesterday afternoon.

In other words, the Treasury and the Financial Services Authority are trying to organise a rescue - but are some way from a decision about what that rescue would be. As I pointed out, any takeover by another bank or banks of B&B (which could involve breaking the business up) will probably need some kind of financial support from taxpayers.

Full nationalisation, which could well include merging B&B with Northern Rock, is very much a last option - not impossible, but the final resort if all else fails.

There are two ways of looking at a merger of B&B with the Rock.

In theory, it could be a sensible way of using taxpayers' money to create a new force in retail banking that could one day be returned to the private sector. And there would be substantial efficiency benefits from eliminating duplicated overheads.

The other way to view such a merger would be as a potentially huge headache for all of us, in that we as taxpayers could end up owning one very big bad bank, generating horrible losses on mortgage lending made at the height of the credit bubble.

Which is why it makes sense for the Treasury and the FSA to attempt to spread the financial risk with a private-sector bank or banks - although in the current climate of fear in banking markets, a solution involving the private sector may turn out to be impossible.

UPDATE 09:37

For the avoidance of doubt, officials from the Treasury and the Financial Services Authority, and executives from Bradford & Bingley, are working this weekend to find a way to put the bank on a more stable footing.

A decision on B&B's future may well be made by the chancellor and the prime minister by Sunday night, before markets open on Monday morning.

One option which I haven't so far mentioned would be to take B&B into public ownership and then immediately - or almost immediately - sell on some of its assets to a private sector bank.

But as of today, the preferred option has not been identified - although it's clear that taxpayers' money will have to be deployed in some way.

B&B will be rescued soon

Robert Peston | 16:50 UK time, Friday, 26 September 2008


Today's 6% fall in Bradford & Bingley's share price means its days as an independent bank look numbered - and there probably aren't many days before we see some kind of rescue takeover.

Bradford & Bingley branchSo before we go on, here's my statutory reassurance: I don't see any reason for those with retail deposits in B&B to get the willies. There's too much at stake (including the stability of our banking system) for the government to allow B&B savers to lose a penny (and there are a lot of ordinary savers' pennies in B&B, more than £20bn of them).

So as and when the worst comes to the worst, B&B will be steered into safe harbour. And unlike the Lloyds TSB takeover of HBOS, taxpayers' money probably will have to underwrite a deal that protects the bank from the fearsome storms in markets

Here's why it's almost impossible that B&B can survive on its own.

At its all-time low closing share price of 20p, this former FTSE100 bank is valued at just £289m. This tiny market capitalisation supports a gargantuan £52bn of assets and - as importantly - £22bn of retails deposits plus £27bn of non-retail deposits.

To be clear, the market cap is not the same thing as regulatory capital.

But what the market cap tells us is that investors believe, rightly or wrongly, that Bradford & Bingley's £1.5bn of equity in its balance sheet - as per its interim statement less than a month ago - will be all-but wiped out by future losses on buy-to-let and self-cert mortgages that go bad.

So the leverage in this bank, as judged by the ratio of loans and assets to its market cap, is a staggering 180 - greater than the most swashbuckling hedge fund at the height of the bubble.

The best way of thinking of B&B is as an inverted pyramid, with a vast mound of buy-to-let and self-cert mortgages bearing down on a tiny and unstable base of quoted shares.

It means that if there are any serious accidents unanticipated by investors, well the whole thing could topple over.

That image ought to be keeping the chancellor awake at night.

And B&B's immediate vulnerability is that the lack of a substantial market-cap foundation makes it harder and harder for it to persuade money-market funds, other banks and financial institutions to provide it with the wholesale deposits and loans on which it depends.

Today's announcement by the Bank of England that it is providing £40bn of new three-month loans to British banks may buy B&B a bit of time - since it may be able to swap some of its mortgage assets for these loans.

But the Bank of England is only prepared to take AAA-rated asset-backed securities in exchange for these three-month loans. And it's moot whether, with so much pessimism around about our housing market, B&B would be able to package enough of its buy-to-let loans into AAA form to receive substantial funding from the Bank of England.

For me, what really matters is that B&B made three announcements this week that in normal times would have been viewed by investors as positive: it reduced the toxic investments on its balance sheet; it announced measures to reduce overheads; and it cut by a useful £1bn its commitment to buy from GMAC a portfolio of mortgages with an above-average arrears problem.

But its share price kept on falling, in spite of what should have been seen as good news.

That focuses minds in the B&B boardroom, the Treasury and at the City watchdog, the Financial Services Authority.

What it will tell them is that B&B is unlikely to regain a sound footing without external help, including a prop (probably) from taxpayers. Which means that a rescue deal can't be far away.

Central banks to the rescue

Robert Peston | 07:28 UK time, Friday, 26 September 2008


The Bank of England and other central banks have announced massive financial help for the banking system - which has been seizing up because of fears of further bank collapses.

They are taking co-ordinated action to lend vital funds to banks for a week, to tide them over till some kind of stability returns to the banking system.

The Bank of England's share of this will be $30bn in one-week money, to be auctioned today, and $10bn of overnight money.

Perhaps more importantly in a UK context, the Bank of England will also on Monday auction a substantial £40bn of three-month loans (which is what I've said in recent blogs was necessary).

And banks will be able to swap their hard-to-refinance mortgage assets for these three-month loans.

This should bring three-month interbank interest rates down a bit, and reduce the pressure on banks to increase what they charge us for finance.

Also, it should reduce the risk that weaker banks will topple over, because of the difficulties they're experiencing in raising funds from the banking system and wholesale markets.

The central banks are responding to a couple of shocking events last night - neither of them completely unexpected, but both of them chilling.

The Republicans in the House of Representatives decided to blow up the Paulson plan.

And although there'll be desperate attempts to put it back together today, my examination last night of whether the $700bn Septic Bank will do an effective job of detoxing the banks and quarantining the poison, well that may turn out to be academic.

We may have to start wondering again what the financial world will be like without the Septic Bank.

There was a glimpse of that overnight, when we saw the biggest banking collapse in US history.

Washington Mutual, the giant mortgage lender, was seized by regulators. That will lead to massive losses for holders of WaMu's shares and bonds - even though JP Morgan has already acquired many of its assets for $1.9bn.

It's by far the largest failure ever in the US With $307bn in asssets, it's 10 times the size of IndyMac, which went down in July.

Think of it as some kind of horrible Olympic record, since the biggest bank failure till today was that of Continental Illinois in 1984.

Bottom line of all this is that the Age of Anxiety is far from over (but then I never thought it would be, even if Paulson's Septic Bank were built).

UPDATE, 04:00PM: A quartet of central banks have given the White House and Congress a few days to sort themselves out, with their co-ordinated action to lend tens of billions of dollars to banks for a week.

Will that be long enough for a workable rescue package to be agreed by the squabbling legislators?

Well, President Bush's remarks a few minutes ago weren't exactly reassuring, viz: "the proposal is big and the reason it's big is because it's a big problem".

Okay. I don't know about you, but I am not sure that provided great grounds for optimism.

The most powerful politician on the planet also said: "there are disagreements over aspects of the plan, but there is no disagreement that something substantial must be done."


Is it time to put all our money into gold coins, baked beans and shot guns - or those essentials for a severe recession as famously recommended by Jim Slater, the investor who helped to engender mayhem in the British banking system in the early 1970s?

Surely not, though I might buy a couple of extra tins this weekend.

A stinking septic bank

Robert Peston | 22:51 UK time, Thursday, 25 September 2008


So it looks as though the Whitehouse will have its wish: Congress will probably allow it to create its Septic Bank, into which $700bn of poisonous excrement will be sucked out of Wall Street.

Assuming there are no further hitches, will this plan to purge the banks actually work?

Well, conditions in money markets have already become a little less fraught - although banks are still reluctant to lend to each and the rates they are charging for doing so for more than a few days remain punitively high.

And stock markets have bounced.

But all that tells us is that immediate Armageddon has been skirted - this time.

The more important question is whether the Septic Bank (a name I nicked from a banker chum who's been around for a few cycles) will be the comprehensive long term solution to the financial crisis which its architect - the US Treasury Secretary, Hank Paulson - wishes it to be.

That is moot.

Paulson would fear - as per his testimony this week - that some of the compromises he's been forced by legislators to agree will limit the bailout's effectiveness.

These concessions include the payment of all that mega-wonga in instalments, so that Congress could cut off the supply after the first $350bn or so, if it didn't like how Paulson bunged the initial hundreds of billions.

Also, he's being forced, against his will, to punish banks and bankers who expel their toxins in the Septic Bank: there'll be limits on the pay of the executives of bailed-out banks.

Also the government will receive warrants over shares (basically equity stakes) in the rescued institutions, in the hope that taxpayers can share in any gains generated as the detoxed banks return to form.

So one unanswerable question is whether poisoned banks will refuse to detox because the price of doing so - in respect of pay cuts and wealth reduction for their shareholders - would be too great?

Such behaviour on their part may be mad and irrational. But it's now clear that bankers haven't distinguished themselves by their rationality over recent years.

Another unanswerable question is whether $700bn will be enough - given that as one set of assets, those linked to subprime, is written off, the economic slowdown we're experiencing in the US, UK and eurozone will lead to vast quantities of conventional mortgages and loans going bad.

Then there's the question I've raised before of whether Paulson will buy these assets at a high enough price to recapitalise the banks, so that they can start lending with confidence again. And to do that he has to in effect absolve them of their past sins, by allowing them to generate a profit from these sales to him.

All of these uncertainties can be boiled down to one dilemma: if the bailout is used to punish the banks it probably won't save the global financial system; but if the banks aren't punished, then US taxpayers may well feel that their pockets have been picked, and that the Whitehouse has allowed the perps to run off with the spoils.

Bank of England unmanned

Robert Peston | 11:52 UK time, Thursday, 25 September 2008


Conditions in money markets have worsened again overnight and this morning.

Rates for lending between banks for longer than just a day or so have risen again.

Bank of EnglandHoarding by bankers is on the rise. Given the choice between making a bit of extra profit by lending cash and simply keeping the cash at hand to meet any possible emergency, well bank treasurers - under pressure from their chief executives - are opting for extreme caution.

This is very bad news for the Bank of England. It means that - again - there has been a partial breakdown in its ability to control demand in the economy, and hence inflation and growth, via changes in its policy rate.

The Bank does not explicitly target three-month sterling Libor, the three-month rate for lending between banks.

But when it moves its policy rate, the Bank of England expects that to have an influence on the rates that households are charged for mortgages and personal loans and that companies are charged for their debt.

The Bank of England hopes to transmit its changes in interest rates to the rates we pay via interbank rates - of which probably the most important is three-month Libor.

So it must be worrying for the Bank of England's Monetary Policy Committee that it has maintained its policy rate at 5% but three-month Libor is well over 6% - and still rising (the BBA's fix this morning was 6.28 per cent, up from 6.2 per cent yesterday).

What's more, this rise in thee-month sterling Libor has come at a time when the market actually expects cuts in the policy rate (as shown by the three-month OIS rate I mentioned yesterday in my note on "interbank hysteria").

There are already signs of banks and building societies pushing up mortgage rates again. And I've been contacted by businesses who say they can't obtain new loans at any price.

The most basic function of the banking system, to channel funds at the right price to those who can best use it, has broken down.

Which, to reiterate what I said last night, is why it is almost inconceivable that the Bank of England won't take corrective action by lending tens of billions to banks at maturities significantly longer than overnight (as I said yesterday, paradoxically there's far too much overnight money sloshing around).

The Bank of England's existing emergency scheme, which allows banks to swap mortgages created before the end of last year for liquid Treasury bills, the equivalent of cash, was helpful. And banks should count their blessings that the closing date for this scheme has been extended to January.

And I can see why the Bank of England may want to wait a bit before doing more - to obtain a firmer grasp of just what kind of bank bail-out scheme may eventually be approved by Congress.

But it may be a long and nerve-wracking wait before a sensible assessment can be made of whether the US Treasury has done enough to restore some kind of stability to the global banking system.

And it may be dangerous to rely too much on the US to solve our domestic banking difficulties.

If we want our banks to do their job properly - if we want the basic infrastructure of the economy to function as it should - the Bank of England will surely have to prime the pump again.

Bank of England must lend

Robert Peston | 00:00 UK time, Thursday, 25 September 2008


The reluctance of banks to lend longer than overnight to each other - as described in my earlier note on interbank hysteria - will surely force the Bank of England to take corrective action.

Bank of EnglandIf it does nothing, well then the cost of money for all of us - in the form of the interest rate we pay on loans - will soar. Which is not what we need when the economy is so weak.

Also an ever growing number of businesses and individuals perceived as even a slight credit risk will not be able to borrow at all.

Money will become painfully tight.

And there could be worse. As the weaker banks become ever more dependent on overnight loans, as they find it increasingly difficult to borrow for any length of time, so grows the danger that one or more of them could suffer a fatal run.

So I expect the Bank of England to provide some of the credit that the banks are unable or unwilling to provide to each other.

This would have to take the form of tens of billions of pounds of loans to the banks at maturities much longer than overnight, including a chunk of three month money.

Maybe the Bank of England will take this evasive action tomorrow. Maybe we'll have to wait a bit.

But with so much fear and uncertainty in the world, it's got to happen soon.

Interbank hysteria

Robert Peston | 16:26 UK time, Wednesday, 24 September 2008


Until money markets go wrong, the rest of us barely know they exist.

But something has gone seriously awry in the interbank market, which is where banks lend colossal sums to each other.

Bank of EnglandThe measure of what's gone wrong is the record gap of almost 1 ½ percentage points - or 145 basis points to be precise - between the interest rate for lending between banks in sterling for three months (what's called three month Libor) and the market's expectation of the average overnight interest rate for the coming three months (or the three month OIS rate).

The gap has never been as wide as that, though it has periodically been over one percentage point since the credit crunch began last August.

Before the crunch, the average gap was 0.1 percentage points (10 basis points).

What that gap shows is that banks are happy to lend for 24 hours, but not for any longer than that.

In fact, banks have more money to lend overnight than they know what to do with.

They are depositing a ton of it with the Bank of England in its standing deposit facility, which pays a paltry penal interest rate of 4%.

Think about that for a second.

Our banks are prepared to lend to the Bank of England overnight at 4%, but not to each other for three months at more than 6%.

What on earth is going on?

Well the background is that banks are rebuilding their balance sheets to cope with the economic downturn we're experiencing, and they're doing that by lending less (and raising new capital).

But the more immediate cause is a sudden flare up - post the debacles at Lehman, AIG and the rest - of fears that no financial institution is safe from collapse.

So bank chief executives and treasurers think it's wiser to hoard cash (or liquidity) than to lend it out, even if that leads to a reduction in profits (which it does).

Also, there's a significant potential funding problem for all banks in the growing risk aversion of US money market mutual funds, which are increasingly reluctant to lend their trillions of dollars for more than a few days at a time (because they were burned on Lehman and because their shareholders are withdrawing cash on a significant scale).

The rise in interbank rates for lending longer than overnight is the most palpable sign of crisis in the global banking system, a crisis engendered principally by fear.

Banks aren't fulfilling their core function, of transmitting money to where it's needed.

It's why Hank Paulson and Ben Bernanke may not be guilty of hyperbole when they claim that their $700bn banking bailout plan may be the difference between life and near death for the global financial economy.

France bets huge on Britain

Robert Peston | 12:40 UK time, Wednesday, 24 September 2008


For those who fear we're in danger of talking ourselves into an irredeemably deep and dark depression about the prospects for our economy, EDF's acquisition of our nuclear power industry can be seen as a powerful message of hope.

British EnergyThe financial commitment being made to the UK by the French state-controlled utility is enormous, in a literal sense.

It may represent the biggest ever overseas investment in the UK, when the various bits are added together.

In round numbers, EDF is paying a touch over €15bn for British Energy's existing assets.

It will spend a further €10bn over the coming 15 years on the construction of four new nuclear generators (the first of which is scheduled to open at Christmas 2017 - and the other three in a rolling programme over the following five years or so).

And it will invest €400m a year maintaining British Energy's existing generators.

That represents an aggregate investment of around €30bn - or £24bn - from now to around 2020, in today's money.

It's a spectacular vote of confidence from La Republique no less that the United Kingdom is anything but bust.

Of course, if the Centrica deal goes through as planned, the owner of British Gas will take on a quarter of that massive financial commitment.

But that deal is not done. And as of this moment, EDF is on the hook for €30bn.

The deal demonstrates that power, especially reliable energy that doesn't emit C02, is almost the most precious thing on earth right now.

But it also shows that there should be plenty of vibrant economic life, once we're through le Crunch (whenever that'll be).

British banks shorted

Robert Peston | 08:44 UK time, Wednesday, 24 September 2008


Prime ministers probably shouldn't use phrases they don't understand.

Gordon BrownGordon Brown, seconds ago, attacked "naked short-selling" on the Today programme, and then went on to describe short-selling covered by borrowed stock (viz short-selling that's not naked).

For next time, prime minister, what you're criticising is all short-selling, not the racier clotheless variety.

Perhaps I'm being pedantic, but these sorts of semantic errors are becoming slightly pathological (go back to the Marr interview on Sunday for more Brown malapropisms on the market).

While we're on the subject of shorting, the scariest disclosure of the past 24 hours was that John Paulson has made bets of around £1bn that the share prices of our biggest banks are on their way down.

He's the hedge-fund megastar, the founder of New York's Paulson & Co, who made several billions last year short-selling collateralised debt obligations.

If he thinks our banks are almost as structurally flawed as investments created out of subprime rubbish, well that's not altogether reassuring.

As for the widespread suggestion that Warren Buffett has just announced a great vote of confidence in the US investment banking system by injecting $5bn into Goldman Sachs, don't make me laugh.

He's demanded, and is receiving, a lovely 10% dividend, which means he views Goldman as a high-risk investment.

This is very expensive money for Goldman, not least because if it wants to buy Buffett out, it has to pay a 10% premium.

And on top of that he gets a warrant to purchase $5bn of common stock which can be exercised at any time in the next five years.

In other words, the world's biggest and most fearsome investment bank has just had its pocket picked by a 78-year-old (albeit the canniest 78-year-old on the planet).

Strange times.

Taxpayers recapitalise banks

Robert Peston | 16:45 UK time, Tuesday, 23 September 2008


There can be no doubt any longer that the US Treasury secretary's proposal to buy bad mortgage debts from banks represents the mother of all bail-outs.

Ben BernankeThe cat was let out of the bag today by the Chairman of the Federal Reserve, Ben Bernanke, in testimony to the senate banking committee.

Chairman Bernanke said that the Treasury would attempt to buy these debts from banks at close to their "hold-to-maturity" value, not the market value.

In practice, it means banks who sell their debts to the Treasury would receive cash equivalent to something like twice the value in their books of these poisonous assets.

In other words banks would book a profit from selling to taxpayers!

It would represent a massive injection of new capital into the US banking system - for which taxpayers would receive nothing in return, except for the assurances from Mr Paulson and Chairman Bernanke that their banking system would not collapse.

US lawmakers may agree to this jaw-dropping proposal. But it won't be an easy sell.

UPDATE, 17:20PM: To elucidate, the "hold-to-maturity" is an estimate of what a loan will repay over the full life of the loan, as opposed to the trading price in the market.

The current trading or market prices for mortgage-backed securities and their more toxic cousins in the CDO world are partly low because the markets aren't functioning: there are no buyers.

So arguably the market prices are too low.

Even so, this seizing up of markets is widely seen as the banks' fault, for the way they lent during the bubble years as if there was no tomorrow.

And to reiterate the big point: Paulson and Bernanke are asking Congress to legislate to allow them to use taxpayers' money to generate massive profits for the likes of Citigroup, Morgan Stanley and Merrill, by buying their poisonous assets at far above what the market says these assets are worth.

I find it difficult to believe that Congress will give its assent, unless there is a massive tit for tat - which could be stakes for taxpayers in the banks, or the wholesale sackings of bank executives, or some other form of spanking.

Actually, just a plain sorry from the banks would probably help.

The next accident

Robert Peston | 08:02 UK time, Tuesday, 23 September 2008


New York State wants to bring law and order to the last wild frontier of global finance, the credit default swaps market.

Wall St, New YorkIt's yet another attempt to close a stable door after a galloping herd has not only bolted but has already crossed the state line.

Credit default swaps are - in essence - contracts to insure debt, especially debt in the form of bonds, against the risk of default.

They began life as a sensible initiative by banks to reduce the risks they were running in lending to companies. Banks used them to lay off the risks of default to specialist insurers and other financial firms.

But as with all good things in global finance, especially the unregulated things, the market then binged on these credit derivatives.

Their use exploded with the boom in collateralised debt obligations made out of subprime loans, because the vendors of these toxic securities took out credit-default-swap contracts to secure cherished AAA ratings - or to turn poo into gold (most of it's since turned back into poo, occasioning great pain for the banking system).

And, in the corporate markets, credit default swaps became an instrument of pure speculation. If hedge funds wanted to speculate on the fortune of a big business, they would often buy and sell these credit derivatives as an alternative to shares.


Well this was - for a while at least - a huge, liquid and unregulated market, a true Wild West, almost free from the nosey attention of sheriffs and regulators who take an annoying interest in what goes on in stock markets.

Anyway the notional value of extant credit derivatives, in terms of the underlying value of the debt insured, was something over $60,000bn at the end of 2007, or more than five times the value of the entire US economy.

However many analysts say the better measure of the size of market is the $2,000bn fair value of outstanding contracts - because that's an attempt to assess potential losses and gains.

Both numbers are big, even if one of those falls into the too-big-to-fathom category.

Perhaps the more important point is that over just the past three years, the size of the market has increased by 15 times.

Which simply tells you that a lot of stupid contracts have been written at the wrong price, since in the two years to August last year most bankers and financial firms were pricing financial risk as though it were a myth from a bygone age.

Anyway it was AIG's exposure to credit derivative contracts that did it in just a few days ago: one of its subsidiaries had to find a colossal amount of cash in a hurry under its credit derivative contracts, because of a contractual requirement to post collateral after its credit-worthiness was marked down by rating agencies.

All of which is to explain why the New York Governor David Paterson issued a statement yesterday saying that his state will regard as insurance, in a formal sense, those contracts sold to investors who own bonds they want to protect from default.

It will therefore require proof from the entities selling the insurance that they have the resources to actually pay possible claims under the relevant contracts.


I'd laugh if I didn't want to cry.

Paterson is implying that many of the writers of credit default swaps don't have the means to make good on their liabilities, that they were taking a punt, hoping to make easy money from insurance they thought would never be claimed on.

It's one of those "emperor's new clothes moments" that leaves me almost lost for words (almost).

To state the bloomin' obvious (as is my wont), we should be worried about this because we are entering a pronounced economic slowdown in which many companies will have difficulties servicing their debt.

And so we will start to see a raft of claims under credit derivative contracts, to add to those already triggered by the collapses of Lehman, Fannie and Freddie.

If the insurers can't pay, well that could lead to losses and pain all over the place, for hedge funds, for pension funds and for banks - which may still be living in the fools' paradise of thinking that their balance sheets are stronger than they are, thanks to all that lovely insurance they've taken out.

PS. Yesterday was a truly horrific day for the US Treasury.

First it learned that investors aren't in love with its bank bailout plan, because of the way that all those liabilities damage the credit-worthiness of the US.

Second, the opposition of influential legislators to the $1.1 trillion bailout has demonstrated in the reaction of markets that no bailout would be worse for the financial system than an unaffordable bailout.

It's going to be another hairy day.

Bye bye bulge-bracket

Robert Peston | 09:43 UK time, Monday, 22 September 2008


That the last two bulge-bracket firms standing, Goldman Sachs and Morgan Stanley, have become licensed deposit-taking banks is extraordinary.

Trader watching shares boardIt is precisely the opposite of what happened after the Great Crash of 1929.

Back then, the US government decided that the best way to protect US citizens' savings was to prevent investment banks having access to those retail savings.

So investment banks which engaged in what was perceived as high-risk securities trading and underwriting were banned from taking insured retail deposits, under the Glass-Steagal Act of 1933.

That prohibition was removed on 12 November 1999 - and since then there has been a rapid convergence between commercial banking and investment banking.

The preferred new banking model became the universal bank, typified by Citigroup, with its mixture of retail banking, commercial banking and investment banking.

The universal model hasn't been an unalloyed success: Citi and UBS, to name just two, have lost colossal sums on their subprime-related investments, imperilling their depositors (though both have survived).

Even so, in the wake of the credit crunch, the new orthodoxy is that all investment banks must have access to retail deposits.

Why? Well this is where it becomes a touch surreal.

First, retail deposits are supposed to be stickier. Or to put it another way, you and I are less likely to panic en masse and withdraw our savings at the first whiff of trouble at our banks.

Banks are counting on our inertia for their survival. Which is not altogether reassuring.

Second, the political and economic fallout from any damage to our savings is such that retail banks that take our deposits receive much greater protection from the authorities than banks that don't look after the public's savings.

In the US context, for example, there's the official insurance provided for deposits. And, more importantly, there's access to the Federal Reserve for day-to-day and emergency funding - which Goldman and Morgan Stanley will be able to access in full, now that they are formal "Federal Bank Holding Companies".

So the conversion into banks by Goldman and Morgan may perhaps be redolent of the greatest failure of global financial regulation over the past decade or so.

The original separation of investment banking and retail banking was designed to prevent ordinary savers from being damaged by the collapse of a Goldman Sachs or a Morgan Stanley.

But Goldman Sachs and Morgan Stanley have been permitted to grow so enormous, and other banks which look after our savings have become so inextricably dependent on them, that even they are now too big to be allowed to fail.

Just a week ago, the US Treasury took a big risk and allowed Lehman to fail.

Since then, the repercussions have almost brought the US, the world's biggest economy, to its knees.

The collapse of Lehman is what - in part - has led to all money-market funds being insured at an incremental cost to the taxpayer of $400bn and to the US Treasury's proposal to spend $700bn on buying distressed mortgage and other assets.

So the attitude of the Treasury and of the Federal Reserve, the US central bank, is that it would be better to allow Goldman and Morgan to become formal banks - benefiting from the full protection of the US government - than to sustain the illusion that they could be allowed to collapse.

But Morgan Stanley's claim that its conversion into a federally insured bank will not lead to "limitations on its activities" will doubtless be viewed by some US politicians as contemptible.

Now that the US taxpayer is in a formal sense underwriting Goldman and Morgan Stanley, their days of buckling the swash on the worldwide high seas of finance are over, possibly for good.

Credit-crunched Gordon Brown

Robert Peston | 07:52 UK time, Monday, 22 September 2008


As a biographer of Gordon Brown and a former FT political editor, I have kept a fairly close eye on our prime minister and on HM Treasury for many years. So, for me, there were a number of jaw dropping moments in his BBC interview yesterday with Andrew Marr.

Gordon BrownThese are they, in no particular order.

1) He said this was a moment in which it was "right" for the government to borrow a good deal more. Well, needs must. The credit crunch and the associated economic slowdown are hammering tax revenues.

In the absence of cuts in public spending, public borrowing next year could be well over 6% of GDP, way above anything we've seen since the early 1990s. The Treasury itself is in something of a funk about the outlook for the public finances.

But the prime minister is positioning his party as the defender of expenditure on public services in these straitened credit-crunched times. He's preparing for a punch-up with the Tories, whom he'll doubtless attack as ruthless plunderers of schools and hospitals. This is where he wants to draw the battle line for the next general election.

But there will be a cost to him. If Brown stood for anything as chancellor it was for prudence and fiscal rectitude. It's goodbye to all that.

2) In the Marr interview, Brown took personal credit for the initiative to clamp down on short-selling, even though the decision to impose restrictions on speculators who profit from falls in share prices was actually taken by the City watchdog, the Financial Services Authority.

It's slightly dangerous for him to undermine the perceived independence of a watchdog he created. Why? Well the FSA didn't cover itself in glory in its regulation of Northern Rock. Is the prime minister now taking responsibility for the FSA's failure to properly assess the risks being run by the Rock? Is he saying that calamity was his fault?

3) Brown said that the current financial crisis was in large part due to the absence of a global regulatory system - and that he had been rebuffed for years by foreign governments in his attempt to construct such a system.

I can only assume that here he's referring to his longstanding attempts to reform the International Monetary Fund so that it could give a louder "early warning" when imbalances are building up in the financial system.

Now there are two things to say about this. First, there were very loud warnings being made about the credit bubble that was being created - by the central bank's bank, the Bank for International Settlements, for example. These were largely ignored in finance ministries, including the Treasury.

Second, there will be wry amusement in Brussels and throughout the eurozone about Brown's claims that he was the champion of more integrated regulation across borders - because for years he and the Treasury battled successfully to prevent tighter Europe-wide regulation of financial services.

Brown was defending the interests of the City. It may well have been the right thing to do. But given the current crisis, the eurozone's less laisser-faire governments will insist that they were right and he was wrong.

4) While we're on about the interests of the City, another part of the Brown brand has been that he would defend our financial services industry more-or-less to the death. Yesterday, with the reputation of big-bonus bankers now on a par with Attila, he put the boot in (although he claimed still to be "pro business" and "pro markets").

That may be good short term politics. But another little bit of what defined him has died.

Also there are still some countries where investment banks, hedge funds and private equity firms aren't perceived as leprosy carriers. If they're on the receiving end of much more opprobrium from the British authorities, there'll be a substantial exodus of them.

Many may say good riddance - unless and until they notice that a big chunk of what has been generating our economic growth has relocated to Switzerland.

5) Brown said that the £100bn of hard-to-refinance mortgage assets that our banks have swapped for Treasury bills, via the Bank of England's Special Liquidity Scheme, is an attempt to "reignite the mortgage market" so that there's both "competition" and "fair prices" for borrowers.

This was a particularly odd claim. If he really believes that's what the scheme was about, then he would have to acknowledge it's been a total flop, since the mortgage market is flatter than a pancake.

But actually, as the Bank of England has made crystal clear, the point of the Special Liquidity Scheme was not to revive the mortgage market. It was to provide liquidity to cash-strapped banks, to prevent any more of them falling over.

If anything, what strikes me most about these remarks is what it may show about his loss of a sure touch when discussing complex but important financial issues.

Anyway, there's more that could be said about the prime minister's re-making of himself (which by the way he and his advisers perceive as a great success). But I'm exhausted trying to fathom the new Brown, so that'll do for now.

Paulson's monster

Robert Peston | 12:56 UK time, Sunday, 21 September 2008


More details have been disclosed overnight about the new state-owned institution being created by Hank Paulson, the US Treasury Secretary, to purchase distressed US mortgages and securities manufactured from those mortgages.

He wants to raise $700bn for this institution, from the sale of US government bonds in tranches of $50bn. That $700bn is about 35% more than the entire annual budget of the US defence department.

And to facilitate the funding, the statutory ceiling on US public debt is being raised from $10.6 trillion to $11.3 trillion a rise of 6.6% - which puts this ceiling at around a fifth less than the entire annual output of the US economy.

According to the draft proposal put to Congress, Paulson would have very wide discretion in deciding precisely what "mortgage-related assets" could be purchased, but they would include "residential or commercial mortgages and any securities, obligations or other instruments that are based on or related to such mortgages".

Banks eligible to sell to this Treasury-owned bank would be banks with significant operations in the US - so, for example, Royal Bank of Scotland (which has a big retail business in the US) and Barclays would be able to dump their toxic mortgage-related investments on the Treasury, but HBOS and Lloyds TSB (which have less of the nasty stuff, in any case) probably wouldn't be able to do so.

As for the mechanism for buying the poisonous assets from banks, a fact sheet put out by the US Treasury talks about using reverse auctions.

This would mean that commercial banks would bid to sell their assets to the Government, and the winning bid - and the clearing price for all bids - would be the lowest price put forward by the banks (hence the "reverse" tag).

The merit in using a reverse auction is that it should provide better protection for taxpayers from future losses, because the Treasury-owned bank would be paying the lowest price acceptable to banks for the assets.

However, the worry would be the one I highlighted in my note of yesterday: if the selling price of these impaired assets was determined by what the most stressed banks would accept, that could force all banks into further writedowns, which in turn would further undermine their balance sheets, and thus enfeeble rather than strengthen the banking system.

So just how big a bank would Paulson's baby turn out to be?

Well if it were buying mortgages and asset-backed securities at somewhere between 10 and 50 cents in the dollar - which is not an unreasonable assumption based on the latest markdowns by banks - it would end up owning assets with an origination value of well over $2,000bn (or $2 trillion).

That would make it about the same size as HSBC, on one measure - so something of a monster.

True cost of the rescue

Robert Peston | 14:27 UK time, Saturday, 20 September 2008


The US Government has just admitted that the financial system was on the verge of total meltdown. And it's right. On Thursday, even blue chip companies were having difficulty rolling over their short-term borrowings.

Armageddon was minutes away - averted by Hank Paulson's plan to insure money-market funds and cut the gangrene out of the banking system.

The US Treasury Secretary is working over the weekend to nationalise around £450bn of banks' balance sheets - equivalent to a third of the British economy.

So, if anything, he was guilty of understatement when he conceded that the "financial regulatory structure is sub-optimal, duplicative and outdated".

However, on Friday - in reaction to all of that - stock markets were partying as though its 1999 again.


That doesn't feel like quite the right reaction to me.

Investors are probably right to conclude that one great source of stress will be lifted from the banking system, as and when Paulson sucks their toxic subprime loans, unsellable asset-backed securities, and radioactive collateralised debt obligations into a vast, lead-lined box financed by US taxpayers.

In the country that brought us Ghostbusters, he is styling himself as the Debtbuster.

And it's not all front: the risk of a calamitous, domino-effect, collapse of banks all over the world - and especially throughout the US - has receded somewhat.

That said, the devil will be in the detail of the mechanics of the rescue. What we don't yet know, for example, is whether Paulson's First Toxic Bank - as I shall christen his vehicle for buying the stinky housing loans - will pay the written-down price for the debt, the market price (which after Lehmans collapse is lower than the written-down price) or a discount to the market price.

This matters.

There is an argument that Paulson should pay a discount to the market price, to protect US taxpayers and soundly spank the banks and their owners.

However if he did that, banks' capital resources would be further depleted, which would further undermine their ability to lend to the rest of us. And it wouldn't do a great deal to reinforce the foundations of the creaking banking system.

But if he bails banks out at the price of this stuff in their books or above, well that would be an acknowledgement that an entire generation of banking executives had behaved wholly irresponsibly in their lending practices for years.

Arguably, they should all be sacked and thrown on to the mercy of a jobs market made all the less kind by their own recklessness.

Let's assume for now that Paulson finds a mechanism to extract the poison from the banks, without enfeebling them in the process. Can we all then breathe a sigh of relief and assume our economic prospects will improve markedly?

Sadly, I don't think so.

Banks, money managers, controllers of trillions of dollars on behalf of the cash-rich states of Asia and the Middle East have all had a painful lesson in the meaning of risk over the past fortnight.

They will for an extended period - possibly years - be less willing to fund our banks without demanding a significant increment in what the banks pay them. That'll increase the cost of money for all of us, which will make most of us feel quite a lot poorer for some time.

Also, you can kiss goodbye to the kind of financial creativity, innovation and competition that accelerated the growth of the UK and US economies over the past few years.

Our retail banks, commercial banks and investment banks will all be subject to much tighter regulation. Which will dampen their growth and their profitability.

Just the elimination of HBOS as an independent bank has removed from the scene a competitive thorn in the side of the other big banks which a few years ago shook them out of their torpor to the benefit of consumers and small businesses - for all that it's patently true that HBOS didn't properly appreciate the risks it was running in the way it financed itself.

The UK's unsustainable economic dependence on the City and financial services is coming home to roost.

The shrinkage of that sector may - just on its own - reduce economic growth by well over one percentage point over the coming year.

But, perhaps more significantly, the cutting down of finance into a smaller more regulated industry, and a semi-permanent rise in the perception of the risks of lending, will reduce the potential growth of the economy, probably for many years to come.

Even after the lean years are passed, and there may be a couple of them to come, subsequent recovery may be lacklustre. After the boom years, we may be entering the dismal grey years.

Will UK rescue banks too?

Robert Peston | 18:05 UK time, Friday, 19 September 2008


It's a bit early for definitive judgements about Hank Paulson's plan to rescue Goldman Sachs and Morgan Stanley - sorry I meant the US economy - because today's statement from the US Treasury Secretary is short on detail and elaborates very little on what I published in my note early this morning.

Which is a bit uncharacteristic of this former banker who learned his trade at meticulous Goldman Sachs (that name again) and ended up as chairman of the bulgiest bulge bracket firm.

For us here in the UK the big question is whether what Paulson's proposing makes it more or less likely that our Government will have to launch a similar rescue scheme for our banks.

As of this moment, the thinking in Government is that Paulson's bail out should improve confidence throughout the global banking system, and thus reduce the likelihood that British taxpayers' money will have to be deployed on buying out stinky assets from British banks, or guaranteeing mortgage-backed bonds issued by them, or the other ways in which our banking system could be partly nationalised.

But ministers are taking nothing for granted. The Treasury is working on a contingency bail-out plan, just in case.

Because there is a risk that if Paulson succeeds in shoring up confidence in US banks, the doomsayers could turn their poisonous speculative attention on the economy perceived to be the next most vulnerable - in the way that the investment bank Lehman Bros became the target after Bear Stearns had to be rescued from collapse.

In that sense, the UK would be Lehman, in that the weakness of our housing market looks rather too much like the weakness of the US housing market - or at least it does in the eyes of the money managers who sit in air-conditioned offices all over the world and decide which banks receive their trillions of loose cash.

And if they withdrew more of their cash from the UK banking system than they did during the wholesale run on Northern Rock last autumn, well let's hope it doesn't come to that.

So what more is there to say about the Paulson plan?

Well it is extraordinary how beneficial for Morgan Stanley and Goldman Sachs the rescue package has turned out to be - especially the provision of insurance for investments at money market mutual funds, which should stem the withdrawals of cash from these funds, and reduces the risk that these funds will cease financing the last two bulge bracket firms left standing.

Or at least it helps Goldman and Morgan Stanley in the short term. Though as I implied earlier today, their originate-to-distribute business models - which helped to pump up the credit bubble that has been pricked with such devastating consequences - doesn't look so gleaming right now.

And their once-ginormous profits from servicing private equity and hedge funds, and also managing their own private-equity and hedge money, is likely to wither to something not so pretty: there's a strong likelihood that the hedge-fund and private-equity industries will be crushed under the combined weight of new legislation and the losses that some funds are incurring.

Perhaps Goldman and Morgan Stanley will become smaller simpler firms, suffering from fewer conflicts of interests, acting a bit less hubristically.

Which, you might say, wouldn't be such a bad thing.

The American way to fail

Robert Peston | 09:16 UK time, Friday, 19 September 2008


The breathtaking rises in the price of bank shares this morning are symptomatic of a stock market that is bereft of reason and is being driven almost purely by hysteria and momentum.

Federal Reserve buildingThey are surging in part because of the FSA's crackdown on short-sellers but mostly because of the overnight news that the US Treasury Secretary, Hank Paulson, and the Chairman of the Federal Reserve, Ben Bernanke, are preparing a bold - or possibly impetuous - plan to tackle what can now be classified as the most severe and intractable malfunction of the banking system since the late 1920s.

As I put it on the Ten O'Clock News last night, yesterday's co-ordinated intervention by central banks, led by the US Federal Reserve, to pump an additional $180bn of short-term loans into the banking system treats only a symptom, not the cause, of banks' reluctance to lend to each other and to us.

It's a stopgap, while Paulson prepares to absolve many of the world's biggest banks of their idiocy during the boom years, by nationalising their bad debts.

To understand the pros and cons of what's being considered by Paulson, it's worth reminding ourselves of what created the latest terrifying phase of the credit crunch.

The ultimate cause is the chronic downturn in the US housing market. The proximate causes are the rotten loans to US homeowners sitting on banks' and other financial institutions' balance sheets that has mullered their capacity to make new loans.

The recent trigger has been the crises at Lehman, AIG, Fannie Mae and so on, which have created a climate of fear, in which bankers and managers of money appear to believe that almost any bank could collapse.

One important new stress has been a significant withdrawal of investors' cash from US money-market funds, because of the perception that the funds aren't as safe as was widely thought - which has in turn deprived banks of an important source of wholesale deposits (this sudden rise in the perceived riskiness of these funds was sparked by the announcement of a loss at the Reserve Primary Fund).

The drying-up of liquidity from money-market funds is in part what drove HBOS to acknowledge that the game was up, and that a rescue takeover by Lloyds TSB was the best form of protection for its savers and shareholders.

To reiterate, the big point is that Paulson is working with Congress on a package of measures that - he hopes - will attack the roots of the crisis.

It would involve buying many hundreds of billions of the banks' bad loans to overstretched US homeowners.

And it would also attempt to re-establish confidence in money-market funds by insuring them, in the way that retail bank deposits are insured against loss.

This would be the mother of all bailouts. It would certainly involve the deployment of hundreds of billions of US taxpayers' money, possibly more than a trillion dollars.

And it comes on top of the $300bn commitment of public money already made by Paulson to the rescue of Fannie, Freddie and AIG.

It all represents a massive humiliation for Wall Street, the giant US financial services industry and bankers supposed to be the canniest on the planet.

Paulson, himself, was one of their ilk, as the former boss of Goldman Sachs.

There will be serious long-term damage to the ability of the US to export its way of doing business to the rest of the world.

The American way of capitalism doesn't seem all that brilliant right now.

In that sense, a degree of moral authority - as well as financial clout - will shift east.

It'll also damage the robustness of the US public finances.

Possibly the biggest risk for the US is that in bailing out the finances of the private sector, Paulson would dent international investors' confidence in the American government's balance sheet - which could ultimately undermine the dollar, push up inflation even more and raise the cost of servicing debt for the US authorities.

Maybe the US is still big enough and powerful enough to persuade the rest of the world to pay for the mistakes of its financial sector - which is broadly what's being proposed.

But, as I mentioned here yesterday, surely it would be more rational for the Chinese to own the American financial system itself, rather than lend to the US Government (and in that context, it's resonant that Morgan Stanley may well be close to selling almost half of itself to CIC, China's state investment fund).

In this game of Wall Street Monopoly, there's no "get-out-of-jail-free" card.

New world order

Robert Peston | 08:11 UK time, Thursday, 18 September 2008


The new rule for any bank or financial institution in the world is don't be too dependent on any one source of funding - because in the stormy conditions on world markets, that funding can disappear, sending said bank crashing on to the rocks.

HBOS logoThat's the main reason why HBOS last night agreed to be taken over by Lloyds TSB for £12bn.

The buffeting its shares were receiving on the London stock market week after week, the perception that it was too dependent on a British housing market heading for serious difficulties, was gradually undermining the confidence of the big institutions that provide around 44% of its funding.

There were signs of lenders to HBOS and depositors taking their cash back and putting it elsewhere.

If that had continued, well the consequences would have been unthinkable.

So the main benefit of its merger with Lloyds TSB is that the enlarged group will benefit from more diverse sources of finance - which should mean, to put it in crude terms, that the beefed-up Lloyds TSB will be less at risk of a run than either HBOS or Lloyds on their own.

It was exactly the same logic which drove Merrill Lynch, the big investment bank, into the arms of Bank of America at the weekend - because all the big investment banks, like Merrill, feel dangerously dependent on retaining the confidence of the big money managers and institutions that fund them.

And it's why Morgan Stanley - Merrill's great rival - is also looking for a partner or owner with more stable sources of funding (it's talking to America's Wachovia and others).

Even Goldman Sachs, the pre-eminent investment bank - in its recent heyday, one of the most powerful institutions in the western world - cannot be confident it can thrive and survive as an independent.

Also the recent behaviour of the US and UK governments has sent out a worrying message to the investment banks and their backers.

The authorities on both sides of the Atlantic have demonstrated that they'll do all they can to protect and preserve institutions that directly touch the lives of millions of people, retail banks such as Northern Rock and HBOS, mortgage funders such as Fannie Mae and Freddie Mac, or even an AIG, which has a huge retail presence.

But the US Treasury refused to prop up Lehman, which was allowed to collapse - and the salient fact about this investment bank is that it was not in retail banking.

The credit crunch is creating a new world order in banking and finance.

It's striking terror into the hearts of hedge funds, who can see their backers head for the hills at the mere sniff of an investment boo-boo by hedge-fund managers.

Conservative institutions, and those with simpler business models and a history of careful management of their funding sources, are the new superpowers.

It's a world in which Bank of America, JP Morgan, HSBC, Santander and even Lloyds TSB have the whip hand.

It's a world in which the Chinese state, if it co-ordinated the investments of its cash-rich institutions, could end up owning more-or-less the entire financial system of the US and the UK.

And it's a world in which even Morgan and Goldman may well have to surrender their proud independence.

The creation of Lloyds HBOS

Robert Peston | 16:46 UK time, Wednesday, 17 September 2008


Here are a few more details about this extraordinary takeover.

1) The price of Lloyds TSB's takeover of HBOS will be around 280p-ish in shares, valuing HBOS at around £15bn. And the terms will be announced tomorrow, probably at 7am.

HBOS signs2) The government will use the "national interest" clause in the law that created the independent competition authorities to over-ride concerns about the huge market share that the enlarged Lloyds TSB will have. But it may have to use secondary legislation (which wouldn't involve any kind of debate in Parliament) to flesh out this clause, to the effect that the national interest would be served by the imperative of maintaining the stability of the financial system.

3) The reason the government is facilitating the takeover is that depositors and lenders to HBOS were beginning to withdraw their cash from HBOS, following all that downward pressure on HBOS's share price. There were growing concerns in the HBOS boardroom that a climate of fear was being created about its future, that could have led to a funding crisis - or a Northern-Rock style run, on steroids.

4) The enlarged group will be subject to competition law. If it exploits its massive market share in an anti-competitive way, the Office of Fair Trading will come down on it like a ton of bricks. But ministers took the view that consumers interests, in this case, were better served by protecting their deposits, rather than worrying about whether the market share of a beefed-up Lloyds was too great.

5) One part of the UK where there will be significant anger about this deal will be Scotland, because HBOS's totemic head office is in Scotland (though since the credit crunch began, HBOS's chief executive - Andy Hornby - has been spending most of his time in London). There will be a perception that the deal will relocate an important financial powerhouse to London. And that's probably true, in a practical sense, since Lloyds' chief executive Eric Daniels spends most of his time at his office in the City. But here's the curious irony: in a formal sense, Lloyds TSB's registered head office is in Glasgow (though that's not where any of the action takes place).

6) Eric Daniels will remain chief executive of the enlarged group. The future of Andy Hornby is unclear.

UPDATE 21:14

I can reveal that both boards have now agreed the takeover, which will be announced tomorrow morning. The price will be 232p per HBOS share in Lloyds shares.

That's a bit less than what both sides shook on 24 hours earlier. I am intrigued to find out how Lloyds managed to screw the price down a bit.

Lloyds to buy HBOS

Robert Peston | 09:00 UK time, Wednesday, 17 September 2008


Lloyds is in advanced merger talks with HBOS to create a giant UK super retail bank, I have learned.

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The deal, if it goes through, would end the uncertainty about the strength of HBOS following the calamitous run on its shares.

And the valuation of HBOS will not be at the current rock bottom price but at a level much closer to the price of last week - so nearer 300p a share.

I'll elaborate later.

UPDATE 09:45AM: The merger of Lloyds TSB and HBOS would end the uncertainties about the future of HBOS, whether it would be strong enough to withstand the downturn in the housing market.

The deal, which could be announced tomorrow, would create a bank valued at around £30bn.

It has the blessing of the City watchdog, the Financial Services Authority, because the enlarged bank would be perceived as better placed to withstand the storms raging through financial markets than either of them on their own.

But the Office of Fair Trading is bound to raise concerns about whether the enlarged bank would have excessive and unfair shares of the mortgage and savings market.

If the deal weren't to happen, there would be a risk that that the extraordinary slump we've seen in HBOS's share price would spook wholesale providers of funds to HBOS - which would be little short of calamitous.

So HBOS depositors should be reassured that Lloyds wants to buy HBOS (because to all intents and purposes it would be a takeover).

The one group weeping would be those who have sold HBOS's shares short - and will now suffer big losses, as HBOS's shares soar.

UPDATE 10:32AM: I am hearing that this deal has been negotiated at a very high pay grade level, with the Prime Minister, Gordon Brown, talking to Sir Victor Blank, chairman of Lloyds TSB, about how helpful it would be if Sir Victor could bring himself to end the uncertainty hanging over HBOS by buying it.

It was not in the government's interest for there to be the faintest risk that it would have another Northern Rock on its hands.

So are there any sticking points. Well, maybe I've slightly over-egged the price that Lloyds TSB will pay for HBOS. Perhaps it will be nearer £2 than £3.

In the end, Lloyds TSB is in the driving seat. It would be, in a way, be a rescue takeover.

And it has a very powerful negotiating position, in that no other British bank - and few overseas ones - have the capital available right now to absorb HBOS.

UPDATE 12:01PM: The big potential obstacle to this deal is the market share the combined group would have in mortgages and savings.

But I understand Lloyds and HBOS have a clever ruse to allay the concerns of the competition authorities - which could in theory block the deal.

It's crucial that there is a way through this competition problem, because confidence in HBOS would be severely dented if there were an extended period of uncertainty about whether the takeover can be executed.

However, for the avoidance of doubt, neither side has asked for taxpayers' money - either from the Bank of England or the Treasury - to facilitate this deal.

All that's required is that Mervyn King, the governor of the Bank of England, is true to his recent word and puts in place new arrangements that would continue to allow all banks to exchange mortgage assets for the equivalent of cash.

Finally I understand there is a bit of controversy out there about what I've said about the price Lloyds would pay.

So for the avoidance of doubt, Lloyds would offer shares as the currency for the takeover (not cash) and as of last night the value per HBOS share of those new Lloyds shares was close to £3.

UPDATE 12:34PM: I now know more about how the competition obstacles to this deal will be surmounted. The government will announce that in the interests of financial stability it will legislate to over-ride the powers of the Office of Fair Trading and the Competition Commission to block the deal.

And it won't be long before the formal terms of the takeover are announced. Both boards met this morning and are meeting again tonight to give their approval.

HBOS: too big to fail

Robert Peston | 08:05 UK time, Wednesday, 17 September 2008


Is there smoke without fire in financial markets?

HBOS logoHBOS thinks there is.

Our leading mortgage lender, owner of the Halifax, believes that the sharp falls in its share price over the past couple of days are a massive over-reaction to the difficulties it faces.

Which is not to say that there aren't troubles ahead for HBOS.

The downturn in the housing market, the growing numbers of people experiencing difficulties keeping up the mortgage payments, are generating losses for all banks.

And the losses are likely to be biggest for Halifax, because it has a massive 20% of the mortgage market.

But HBOS recently raised £4bn in new capital to cushion itself from the effects of those losses.

It and the City watchdog, the Financial Services Authority, believe that's enough for it to cope with the housing-market stresses and strains that lie ahead.

However those who finance HBOS - depositors and providers of wholesale funds - could disagree, and they could decide not to take the risk of hanging around to find out if HBOS and the FSA are right to be so confident.

If they withdrew their funds, that would create a serious crisis, although as HBOS and the FSA have pointed out, there's no sign of such a withdrawal of credit from HBOS.

But even if the appalling and unthinkable were to transpire in that way, there's little reason - in my view - for Halifax savers and depositors to fear that they'll lose their savings.

HBOS is one of those rare banks that's absolutely central to the financial system.

The economic jolt that would be engendered to the UK economy if HBOS went down, wreaking havoc for millions of savers and for the housing market, would be catastrophic.

So the government would be obliged to bail it out, long before that happened.

HBOS is, in the jargon of regulators, far too big to fail.

Savers wouldn't be allowed to lose a bean, though the same cannot be said of HBOS's shareholders.

If HBOS were to collapse - and for the avoidance of any doubt, that's not what I expect - they would lose everything.

Which in itself would not be a trivial event, since HBOS's shares are held by some two million British people.

How banks depend on AIG

Robert Peston | 16:40 UK time, Tuesday, 16 September 2008


Ken Lewis, the chief executive of Bank of America, said yesterday that "I don't know of a major bank that doesn't have some significant exposure to AIG".

American International buidling, New YorkSo AIG's need to raise billions in new capital to shore itself up has sent shockwaves through global markets and helped to undermined the share prices of many banks.

But how exactly are banks "exposed" to AIG?

Light is shed by an insightful bit of research by Sandy Chen of Panmure Gordon.

He has found the following paragraph in AIG's US regulatory filing:

"Approximately $307bn (consisting of corporate loans and prime residential mortgages) of the $441bn in notional exposure of AIGFP's super senior credit default swap portfolio as of June 30, 2008 represented derivatives written for financial institutions, principally in Europe, for the purpose of providing regulatory capital relief rather than risk mitigation. In exchange for a minimum guaranteed fee, the counterparties receive credit protection with respect to diversified loan portfolios they own, thus improving their regulatory capital position."

If you managed to read to the end of that, your reaction is probably "you what?"

Well, I'll tell you what.

AIG is saying here that it has insured $307bn of corporate loans and prime residential mortgages that are on the balance sheets of banks, mostly European banks.

The banks have bought this insurance to protect themselves against the risk that these loans would go bad, that borrowers would default.

Their motive for doing so was to reassure their respective regulators - such as the FSA for UK banks - that these loans are of minimal risk.

And the benefit of doing that was that they could lend considerably more relative to their capital resources.

But if AIG is in trouble, then doubts arise about whether it would be able to honour the financial commitments it has made through these insurance contracts (which, for those of you who like to learn the lingo, are called super senior credit default swaps).

In fact, in a wholly mechanistic way, the downgrades of AIG's credit rating that we saw last night automatically increased the perceived riskiness of loans made by banks that have insured credit with AIG.

Which means those banks' balance sheets become weaker - and that could mean that they'll be forced by their regulators to raise additional capital.

So there's a widespread view among bankers that the US Treasury and the Federal Reserve simply can't allow AIG to fail, in the way that they felt that they could allow Lehman to collapse into insolvency.

If AIG went down, a number of banks' balance sheets would be mullered - there would a dangerous risk to the stability of the global financial system.

Or to put it another way, AIG is so pivotal in the global financial system, it can't be consigned to the dustbin of history in a precipitous way.

PS. For those of you who currently have the willies about HBOS, its exposure to AIG is not life threatening.

What's currently doing for HBOS's share price is blindingly obvious: it provides 20% of all UK residential mortgages; the UK housing market is the major vulnerability of the UK economy; if there's a sharp rise in the number of homeowners defaulting on their mortgages, HBOS would incur significant losses, especially on self-cert, buy-to-let and loans with a high loan-to-value ratio.

But HBOS has recently raised £4bn of new capital to cushion itself against the impact of just such a debacle.

So there is more fear than reason underlying the success of the short-sellers in driving down HBOS's share price - although the short-sellers will claim a modest victory in the decision by Standard & Poors to lower HBOS's credit ratings by a smidgeon.

But HBOS's ratings remain pretty strong. And the rating cuts shouldn't lead to a sharp increase in the cost of its finance or to an exodus of those who provide that finance.

UPDATE 19:25

I suspect that Sandy Chen has found only a part of AIG's credit protection business, since I am told that US banks are more exposed to AIG than are European banks (which is not what the regulatory filing spotted by Chen shows).

And here's a compelling wrinkle. AIG writes its credit default swaps contracts (its loan insurance business) through a French banking subsidiary.

Even so, the possible collapse of AIG isn't a French problem. What AIG needs to obtain is financial support from the American taxpayer at the top holding company level in the US - and it would then use these funds to recapitalise the French bank it owns.

What this shows is the fearful complexity of AIG's corporate structure, which just adds to the difficulty in negotiating a rescue.

Profiting from fear

Robert Peston | 09:10 UK time, Tuesday, 16 September 2008


Alistair Darling has just signalled on the Today Programme that he is profoundly uncomfortable with the widespread practice of profiting from the woes of companies perceived as vulnerable through short-selling their shares.

HBOSThis is highly relevant right now, in that shares in HBOS - our largest mortgage lender - fell by more than 30% at one stage yesterday, which would have been unthinkable a few months ago. And they've fallen again this morning.

If you are running a huge deposit-taker like HBOS you can't dismiss that kind of share-price fall as just one of those things, a stock-market phenomenon that'll pass.

There's always a risk of contagion from equity markets to credit markets.

Or to put it another way, the HBOS chief exec would be anxious (to put it mildly) that those who fund his bank - who lend to it - would get the heeby-jeebies from what he would see as an over-reaction on the stock market to the demise of Lehman.

If you have your savings with HBOS, if you're a money manager that has lent HBOS many tens of millions of pounds, it's hard to shrug off what looks like investors screaming that there's a fire at HBOS.

Those investors may be hysterical, alarmist and misguided. But how can HBOS's creditors be absolutely sure of that?

And if these creditors decided not to hang around to find out, and simply withdrew their credit from HBOS, well that could turn stock-market rumour and speculation into a reality - as no bank can survive as and when it loses the confidence of its creditors.

Which is why the Chancellor was unambiguous this morning that something should be done about speculative short selling, or the practice by hedge funds and others of selling shares that they don't own (shares they've borrowed) with a view to buying them back at a lower price and pocketing the difference.

However he neatly passed the buck to the regulator, the Financial Services Authority, saying that it was looking at how and whether to restrict short-selling in these febrile conditions.

And it won't be easy for the FSA to sort this.

First, short-selling (as I've said many times) is not evil, in and of itself. In fact, short-sellers perform a public service when they take a risk to puncture the over-valuation of assets, as they routinely do.

Second, in global markets it's hard for any single national regulator to take a stand against a practice like short-selling, when investors can simply move their activities offshore.

But it would probably be foolish for the authorities to plead impotence - because the consequence might be a much bigger mess for them to clean up, as and when the short-sellers spark a fully fledged banking crisis.

Barclays wants Lehman rump

Robert Peston | 08:09 UK time, Tuesday, 16 September 2008


Barclays has decided to try to "buy" the core of Lehman, its US broker-dealer business and its mergers-and-acquisitions team.

The best way of seeing this is not as a purchase of assets. Barclays does not want either Lehman's toxic investments in the residential and commercial property markets, nor does it want to unwind its extant, unsettled transactions.

What it wants is the 8,000 to 10,000 US employees which it sees as formidable profit generators.

But the value of these employees' relationships with clients is withering by the hour.

So if Barclays is to pick them up out of insolvency, it has to move fast.

If a deal is done, it'll be completed in hours.

As for the 5,000 Lehman staff in London, the outlook for them remains gloomy - since, as of now, it's unlikely Barclays will hire them (though that could change).

The big question for Barclays' shareholders is whether the bank will need to raise new capital to fund this deal. I wouldn't rule it out.

But history shows that the biggest investment gains are made by those who buy when all around are panicking that the end is nigh, when markets are close to bottom.

So if Barclays picks up the rump of Lehman, it may look very smart a few years from now.

Bank spanked - who weeps?

Robert Peston | 16:45 UK time, Monday, 15 September 2008


For those who believe in free markets, it's a good thing that Lehman has gone bust.

Leyman office in New YorkWhy?

Well a corollary of having the freedom to make hay or fat returns when the sun shines is that banks should suffer for their mistakes.

But ever since the credit crunch set in last year, the US Treasury and the UK government have bailed out banks that ran into trouble

They feared that if Fannie Mae, Freddie Mac, Bear Stearns and Northern Rock had been allowed to collapse, the havoc wreaked on global markets and economies would have seen excessive pain inflicted on too many innocent people.

The problem with these bail outs is that they provided comfort to banks that they could make stupid mistakes and get away with it (well, to an extent).

Not any more.

The US Treasury has well and truly re-established moral hazard - the idea that banks should pay for their sins - by refusing to use taxpayers' money to support Lehman.

And make no mistake, this is a huge insolvency filing, the biggest in US corporate history, with $613bn or £340bn owed to creditors - equivalent to around a quarter of UK economic output.

Big banks can no longer be under any illusion that they can make big, stupid financial bets and expect taxpayers to pick up the bill when the bets go wrong.

Which most taxpayers may feel was a lesson worth teaching - unless they're all impoverished ultimately by collateral damage to other banks and a potentially negative impact on global growth.

Let's hope, for all our sakes, that Hank Paulson's decision to punish this big bank doesn't end up hurting us (and him) disproportionately.

Meltdown Monday

Robert Peston | 06:53 UK time, Monday, 15 September 2008


There has never been a weekend like it in my 25 years as a financial journalist.

Lehman building, New YorkFor Wall Street, it has probably been the most extraordinary 24 hours since the late 1920s.

As I said would happen yesterday evening, Lehman has announced that it is filing for bankruptcy protection under Chapter 11.

To prevent contagion to the next most vulnerable investment bank, mighty Bank of America is buying Merrill Lynch for about $50bn.

That Merrill is steering itself into safe harbour, no longer confident of its future as an independent, is almost as shocking as Lehman's demise.

And one of the world's biggest insurers, AIG, is reeling from losses on its exposure to real estate and credit default swaps, or complicated financial insurance - and, according to the New York Times, is seeking a $40bn bridging loan from the Fed.

As for the US central banking system, the Fed, it is endeavouring to minimise the damage to the financial system from these shocks by allowing securities firms to swap shares for short-term loans, to tide them over.

The Fed is also increasing by $25bn the amount it is prepared to lend to bond dealers.

And a group of 10 banks, including Citigroup, JP Morgan and Goldman Sachs, have created a $70bn collaborative fund, to try to prevent market liquidity from evaporating in the coming anxious hours.

The global financial economy has never in recent years been tested by quite such a combination of accidents and jolts to confidence.

In a way it's fortunate that most Asian markets have been shut today. But the dollar has inevitably fallen in what little trading there's been, Australian stocks have fallen, and futures prices are pointing to a very weak opening on Wall Street.

For most investors and bankers anywhere in the world, today will be a day to endure and survive.

UPDATE, 11:30AM:

Probably the most positive development in the past 24 hours is that 10 of the biggest US banks are pooling their cash in a collaborative effort to prevent any of them running out of funds in an emergency.

Each of them is contributing $7bn and each can borrow up to $23bn from the common pool.

The members of this liquidity consortium include our own Barclays, along with Citigroup, Goldman Sachs, JP Morgan, UBS and others exposed to the fallout from the collapse of Lehman.

The initiative represents an outbreak of common sense among the banks - because in this time of chronic market dislocation, it's a way of ensuring that cash gets to where it's most needed.

The crisis in the global financial economy doesn't stem from their being too little cash in aggregate. It's simply that much of it isn't where it's most needed.

A useful analogy would be Eric Morecombe's protest to Andre Previn in the classic sketch that he was playing all the right notes of Grieg's Piano Concerto, but not necessarily in the right order.

It wouldn't do any harm for the US cash cooperative to be replicated over here by our banks.

There's a time for cut throat competition between banks, and this probably isn't it.

Lehman: insolvency looms

Robert Peston | 20:07 UK time, Sunday, 14 September 2008


Preparations have been made for Lehman Brothers, the substantial US investment bank, to obtain protection from its creditors under US Chapter 11 insolvency procedures.

Lehman Brothers building, TokyoI have also learned that PWC, the leading accountancy firm, has been lined up to run the UK operations of Lehman in the event that it is put into administration under our insolvency arrangements.

The preparations for insolvency protection have been made because the US authorities have become gloomy that Lehman can be rescued.

"The only thing that can prevent Lehman collapsing would be a huge injection of taxpayers' money" said a banker close to the rescue negotiation. "Hank Paulson [the US Treasury Secretary] has made it clear he doesn't want to do that."

If Lehman is put into Chapter 11 tonight, the impact on global markets tomorrow could be very significant.

The withdrawal of Barclays from negotiations to buy most of Lehman - which I reported earlier - left only Bank of America as a potential rescuer.

And Bank of America is - according to bankers - not persuaded that acquiring Lehman is in the iterests of its owners.

The stumbling block is that no bank or other financial institution wishes to take on Lehman's massive liabilities without some kind of protection or guarantees from the US government.

But the US Treasury is reluctant to commit taxpayers' cash to a bailout of Lehman.

It believes that the markets can cope with the shock of Lehman's collapse - though this is disputed by senior bankers.

If Lehman collapses, this would mark a dramatic change in approach to coping with the credit crunch by the US government and the US central bank, the Federal Reserve.

They committed taxpayers' cash to rescuing Fannie Mae, Freddie Mac and Bear Stearns when they ran into serious difficulties. But Hank Paulson has apparently decided that enough is enough, and that taxpayers' cash should not be committed on this occasion.

However, whether he will continue to hold his nerve and will continue to sit on his hands as the deadline for Lehman to be put into Chapter 11 approaches, we shall see.

UPDATE 10.45PM: Sometime before midnight US time, Lehman is expected to file for Chapter 11 and go into administration over here.

I have been told that its executives are seeing the New York Fed right now to investigate whether it can borrow several billion dollars so that it can go into an orderly liquidation as an alternative to formal insolvency.

But Lehman executives do not expect the Fed to give them the funding that would be required, so they assume their business will formally collapse.

The implications will be huge. If the new controllers of the business in insolvency feel obliged to sell assets, that could do severe damage to other banks, because there would be a sharp fall in the market value of those assets.

In the round, the collapse of Lehman would knock bankers' already enfeebled confidence. They will become even more reluctant to lend to most of us. The credit crunch would take a turn for the worse.

Even in terms of the impact on unemployment, the damage will be considerable - in that Lehman employs around 25,000 worldwide, including 5000 in the UK.

I am hearing that the US Treasury and the Fed hope however that the contagion to other banks shouldn't be too appalling - in that Bank of America appears to be close to buying the next most vulnerable investment bank, Merrill Lynch

In respect of shocks to Wall Street, there hasn't been a weekend like it for something like 80 years.

Lehman: Barclays walks

Robert Peston | 18:11 UK time, Sunday, 14 September 2008


I have learned that Barclays has pulled out of negotiations to buy most of the troubled investment bank, Lehman Brothers.

It's decision, which was described by an executive close to the negotiations as "pretty definitive and unlikely to change", is a setback for attempts to rescue Lehman, which are being coordinated by the US Treasury and the New York Federal Reserve.

Barclays has walked away because it was unable to obtain guarantees - from either the Treasury/Fed or other commercial organisations involved in the rescue attempt - in relation to financial commitments faced by Lehman when markets open tomorow.

"It was impossible to find a solution to the problem of Lehman's immediate financial obligations in the time available," said the executive.

These obligations, on outstanding transactions by Lehman, run to billions of dollars and would be difficult to finance at the best of times, But in the light of the credit crunch and the parlous state of financial markets, Barclays feels it would be running a crazy risk if it took these on without any protect right now.

HSBC: reform bankers' pay

Robert Peston | 00:00 UK time, Saturday, 13 September 2008


Bankers' pay needs to be reformed so that they are no longer handsomely rewarded for deals that turn bad, says the chairman of the world's second biggest bank.

Stephen Green the chairman of HSBC, says in a BBC interview:

"I think it is important and will become much more the focus of attention to ensure that remuneration schemes operate in a way that is lined up with the long term interests of the owners of the business.

"There has been far too much focus on payments that are very short term focused, people who pick up the tab for short term profits, without having to bear the costs of long term impairments.

"At the end of the day I think it is right for the market to set compensation levels but it must do so in a way that is consistent with the long term interest of the market as a whole..and the shareholders' of a given institution in particular."

Green was interviewed by me for the BBC News series Leading Questions. The full interview will be broadcast tonight at 9.30pm and can also be watched by clicking here.

In the interview, Green also discusses whether there has been a decline in ethical standards in banking, the lessons for banks of the credit crunch and how to win business in China


Few bankers have stood up and admitted that remuneration in their industry was one of the causes of the credit crunch.

And none have done so who are as influential as Stephen Green, chairman of the world's second largest bank, HSBC.

So it matters that Mr Green concedes that some bankers were paid too much for deals that may have yielded short term profits but ended up costing their institutions a fortune.

He says - what has been blindingly obvious to those outside his industry for some time - that bankers' pay must be reformed, so that bankers only receive fat rewards as and when their transactions yield sustainable long term profits.

We should probably all breathe a sigh of relief at this acknowledgement that banks' current woes, the erosion of their capital which makes it harder for them to lend to us, was self-inflicted - that the crunch was the consequence of deals done in haste by bankers whose judgement was impaired by greed.

But it's all very well to recognise the need for reform. It's quite another to actually get all banks and bankers to sign up for what many of them will see as a pay cut.

Lehman on critical list

Robert Peston | 10:27 UK time, Friday, 12 September 2008


The game is up for Lehman Brothers, the fourth largest US investment bank.

Lehman Brothers officeTalking to bankers overnight, it's clear that Wall Street has lost confidence in its capacity to survive as an independent - which is only to state the obvious given what's been happening to the price of its bonds and its shares.

What's done for it is its $54bn of unwritten-down illiquid commercial and residential property assets - the equivalent of being weighted down by a concrete block in the middle of the Hudson River.

So it needs to find a bigger, sounder bank to rescue it and fast. As I mentioned earlier this week, Bank of America is being touted as the most likely saviour, if any can be strong-armed by regulators into swallowing this big, bloated and poisoned beast (our own Barclays will try to pick up Lehman's better people, in what might be described as muscular pragmatism - but Barclays shareholders would go bananas if it took over the whole ailing thing).

But will anyone take on the risk without some support from taxpayers?

The US Treasury may - so soon after propping up Fannie and Freddie - have to provide some backstop underwriting for Lehman, so that an orderly resolution of Lehman's woes can be achieved.

When confidence in a bank erodes, it ebbs at first and then is gone in a great whoosh. Lehman will be lucky to end the day as an independent bank.

UPDATE: 17:51

Lehman is racing to meet a deadline of Sunday night to find a new owner for the troubled bank.

Bankers close to Lehman warn that failure to conclude a deal by then would be devastating for confidence in the fourth largest Wall Street firm.

"If a solution isn't found by the time Asia opens for business on Mondau, well the consequences would be disastrous" said a senior banker.

He added that the US Treasury was working assiduously behind the scenes to facilitate a takeover of the bank.

The leading candidate to buy Lehman for a knockdown price is Bank of America, although Lehman is talking to a number of other potential bidders.

Lehman's fund management business, which is in relatively good shape, may be sold separately.

UPDATE: 18:56

Barclays position on Lehman has changed during the day. It is now looking at playing a role in the rescue of the troubled investment bank, by buying all or part of it.

But a US solution, led by Bank of America, is still the most likely outcome.

I suspect it won't be many hours before we see the detail of the rescue plan.

Mervyn King insures the banks

Robert Peston | 11:11 UK time, Thursday, 11 September 2008


There is a very strong hint this morning from Mervyn King that the Bank of England will continue to allow banks to swap mortgages for cash (or more precisely, to swap mortgage-backed securities for Treasury Bills) after the Special Liquidity Scheme closes on October 21.

Mervyn KingThat was expected by the chief executives of those running our capital-constrained banks, but the confirmation will still come as a relief - and should at least prevent any further tightening of conditions in money markets and reduce the risk of any further reduction in the volume of mortgage finance offered by banks.

King hasn't divulged the detail of what he calls a new "liquidity insurance facility".

But, in evidence to the Treasury Select Committee, he outlined what he would want to achieve with this facility - from which a good deal can be extrapolated of some significance for most of us (so please read on, even if some of the technical detail seems baffling).

Perhaps the most important implication of what he said is that the Bank of England will swap liquid government paper for securitised mortgages only for short periods - which is the equivalent of providing loans to the banks for just a few weeks at a time, rather than for the three-year term of the Special Liquidity Scheme.

His reason for the switch to short-term funding from long-term funding is that he wants to insure the banks against disaster and collapse that could stem from a sudden unexpected withdrawal of cash or liquidity.

But he doesn't want the Bank to be influencing the banks' commercial lending decisions by becoming a permanent regular funding source for them. Or to put it another way - and don't groan if you've just been refused a mortgage by a bank - he doesn't want to do anything that would encourage the banks to lend more than the diminished sums they are currently lending.

That said, my understanding is that banks will be able to swap new mortgages for cashable government securities in the revised liquidity insurance arrangements that will shortly be announced. That's a big change from the Special Liquidity Scheme (SLS), which would only take as collateral those mortgages that had been signed off by the end of last year.

Bank of EnglandIt means that even those banks that have taken full advantage of the SLS, and have already dumped all or most of their older mortgages assets on the Bank of England, should be able to continue lending to home buyers.

Mervyn King said his primary aim is to "smooth the adjustment of financial institutions hit by financial shocks" - or to give them confidence that if they can't raise cash from their assets in the normal way by tapping commercial, wholesale sources, the Bank stands willing and able to fill the breach.

What's being proposed might not have been sufficient to have prevented the collapse of a bank like Northern Rock, which was probably over-dependent on unreliable wholesale funding. But it should mean that henceforth most banks won't be able to fail purely because of an inability to acquire short-term funding to meet immediate and pressing needs.

But perhaps more important and more resonant is the following statement from King:

"It is not the purpose of central bank liquidity insurance to provide a source of long-term funding to the financial system - indeed it cannot do that. Only private savers or taxpayers via the government can provide such funds.

"So I hope everyone will understand that the proposals to be published next week, important though they are, will not and cannot solve the shortage of funding to finance bank lending, including mortgage lending."

Or to put it another way, King has passed the buck back to the Treasury to decide whether further measures are required to revive the flat-as-a-pancake mortgage market.

And as I've pointed out here before, King has made it crystal clear that he believes it would be wholly inappropriate for taxpayers' money to be used to suck substantial funding back into the mortgage market.

Which presents something of a dilemma to a government fearful of being seen to do nothing to address the credit drought that, as King admits, is one of the main causes of the painful economic slowdown we're experiencing.

Has Lehman done enough?

Robert Peston | 12:17 UK time, Wednesday, 10 September 2008


Lehman is currently Wall Street's most important investment bank, but not in a way that gives it any pleasure.

Lehman Brothers officeIts woes yesterday socked bankers and investors between the eyes, just as they dared to hope that the US government's rescue of Fannie and Freddie was a reason to be a little more cheerful.

What Lehman reminded them is that any recovery in the US residential and commercial property markets are some way off - and that the deep recession in those markets is still spilling over in poisonous ways all over the place.

That sent the US stock market into a tailspin - and once again shares are showing the classic bear-market tendency to take one stop forward followed by two steps back.

After it emerged that Lehman's attempt to raise billions of dollars in vital new capital from Korea Development Bank had run into a brick wall which may prove insurmountable, its own share price tumbled 45 percent - and it was forced to bring forward to today an announcement of what it can do next to shore itself up and the publication of its third quarter financial results.

In pre-market trading, Lehman's shares bounced up by 27 percent this morning.

Wall StreetSo is Wall Street's fourth biggest investment bank in better shape than yesterday's doomsayers feared?

Well the headlines look horrible.

Its net loss for the three months to the end of August is estimated by the firm at $3.9bn - after a gross mark-to-market loss of $7.8bn on all those unfortunate investments in residential mortgages and commercial real estate.

But, for the avoidance of doubt, this firm is not bust nor seems in imminent danger of collapse.

It reduced its leverage - the ratio of its loans to equity - from 12.1 to 10.6. And it has increased its stockholders' equity from $26.3bn to $28.4bn.

Most important of all in these nervous times, its pool of liquidity is $42bn - which looks ample to meet any unexpected calls on its cash.

But that doesn't mean it is in good shape. It still has $54bn of exposure to illiquid and hard-to-monetize commercial real estate, residential mortgages and high-yield acquisition finance.

As worrying for Lehman is the massive damage inflicted on its brand by all the negative publicity generated by its struggles - which increases the challenge in retaining clients, let alone winning new ones.

So nothing less than a reconstruction of the firm is required. Today Lehman has disclosed that it is spinning off the majority of its real estate assets into a new, separate public company - which is the equivalent of cutting off a gangrenous leg.

And Lehman wants to sell a majority stake in its fund management business, to swell its tangible assets by $3bn or more while retaining a healthy slug of the income from this operation.

Will these writeoffs and proposals be sufficient to persuade Lehman's shareholders and customers that it has grasped the horrible reality of its plight and is over the worst?

Or will the slow, potentially lethal erosion of confidence in the firm continue?

Well, one senior banker there has told me that he doesn't think Lehman's decline will be arrested unless and until it can find a bigger sounder bank - such as Bank of America, HSBC or Nomura - to purchase it.

But he fears that won't happen while many of Lehman's executives retain an inflated view of what their business is worth in this credit-crunched world.

Why banks won't lend

Robert Peston | 19:40 UK time, Tuesday, 9 September 2008


How much of banks' current reluctance to lend is determined by their reduced ability to raise funds from wholesale markets and how much by their perception that the risk of lending has increased?

This matters, because it will determine whether the Government is wasting its time in looking for ways to encourage banks to lend more for mortgages, for example.

Or to put it another way, there would be little point in the Treasury using taxpayers' money to persuade global investors to end their funding boycott of the British banking system, if our banks were not to transmit those funds to cash-strapped companies and individuals.

Quite an important clue to the answer is given today by new Bank of England figures on average interest rates charged by banks for mortgages and for unsecured personal loans.

The first relevant fact is that the Bank of England's policy lending rate has fallen by three-quarters of a percentage point over the past year.

And that has not been passed on in full by most banks for most loans.

Thus last July the average monthly interest rate for two-year fixed rate mortgages with a requirement for a 25 per cent deposit was 6.07 per cent. In August the same loan was priced at 6.08 per cent.

Which is so close as to make little difference.

Also, arrangement fees for such loans have risen, so the overall cost of the loan has gone up.

That said, there has been a fall in the cost of variable rate mortgages over the same period, from 7.44 per cent to 6.92 per cent - or a bit less than the drop in the Bank of England's policy rate.

But here's one of the most dramatic changes: in July 2007 a two year fixed rate mortgage covering 95 per cent of the price of a property carried an interest rate of 6.33 per cent; from May, the Bank of England stopped publishing the cost of such loans, because most banks had stopped offering mortgages that required such small deposits.

What's preventing the full reduction in the Bank of England's policy rate being passed on to us?

In part it's that banks simply can't obtain the funds to lend from wholesale markets, or are being charged considerably more than the policy rate when they can obtain these funds.

That's the classic credit-crunch effect.

But there's also a strong element of banks' deciding to become more averse to risk - you can see that in the disappearance of high loan-to-value mortgages.

Here's the significance of what Graham Beale of Nationwide said to me yesterday. When he made his prediction that that the peak-to-trough fall in house prices over the current cycle would be 25 per cent, he was signalling that Nationwide wouldn't dream of providing 100 per cent loan-to-value mortgages.

Nationwide is demanding big deposits from its customers, precisely because it thinks house prices are falling.

So like all banks its lending policy manifests a growing aversion to the risks in the housing market.

The Bank of England's data shows that this new risk aversion has been even more pronounced in the provision of personal loans.

Over the past year, the average interest rate on a £5,000 loan has risen by more than three percentage points to 12.37 per cent and that on a £10,000 loan has increased by two percentage points to 9.42 per cent. Overdraft and credit card rates have also inched up.

This shows that banks are factoring in the impact of an economic downturn on the ability of their customers to keep up the payments - and never mind that the banks are making their nightmares a reality, that they are exacerbating the downturn, by restricting credit and making it more expensive.

The banks have their eyes wide open when increasing these interest rates. In the past few days, the chief executives of two of our biggest lenders - Andy Hornby at HBOS and Beale at Nationwide - have both told me that it's imperative they charge higher rates to reflect what they perceive as the increased risks of lending.

Bottom line?

Even if there were a sudden increase in the availability of wholesale funding, our banks are not going to start lending 100 per cent mortgages to first time buyers or providing unlimited funds for buy-to-let landlords.

The shortage of credit will persist, because banks only want to lend to a minority of borrowers who are rock solid.

In other words, the Treasury's agonising about whether to use taxpayers' money to underwrite the mortgage market may be fatuous - in that banks wouldn't lend much additional money even if they had it.

'House prices to fall a quarter'

Robert Peston | 16:45 UK time, Monday, 8 September 2008


Nationwide is one of the Big Three providers of mortgages and closer to the housing market than most financial institutions.

Nationwide building societyAs by far the UK's biggest building society, over the course of the cycle it provides slightly fewer than one in 10 of all the mortgages in the UK - though its recent share of new homeloans has been a bit less.

So Nationwide's chief executive, Graham Beale, carries weight when prognosticating.

What he has told me in an interview today is that he doesn't expect the housing market to show signs of recovery till 2010 (click here for an excerpt).

And he also forecasts the peak-to-trough fall in prices will reach 25%.

That's a very significant drop.

It would mean that a typical house would have decreased in value by a quarter during the two-and-a-bit years from last autumn to some time in the next decade

If Beale's right, some 2.5 million homeowners would for a period suffer from negative equity (according to research by Michael Saunders of Citigroup).

That would mean 22% of all householders with mortgages would have homeloans greater than the value of their respective homes.

Beale believes that there's little the government or anyone can do to stem in any significant way what he believes is a necessary adjustment of prices.

For him, the US Treasury's colossal scheme to shore up the two great providers of housing finance, Fannie Mae and Freddie Mac, should help to restore confidence in financial markets, but can't swiftly revitalise our housing market - even though our prospects are inextricably linked to prospects for the US residential property market, because of its importance for the funding of the global financial system.

That said, our government is under pressure from banks and building societies to help them raise money so that they can lend a little more to us in the form of mortgages.

The two options being considered at the Treasury are to provide a taxpayer guarantee for mortgages packaged up as bonds for sale to investors, or to extend an existing Bank-of-England liquidity scheme so that it could help banks to refinance new mortgages.

Both options would be designed to increase the confidence of global investors that money they provide to banks for lending in the form of mortgages would be safe.

And both options are loathed by the Governor of the Bank of England, Mervyn King, because he believes they could distort the housing market.

Which creates the tantalising prospect of a serious showdown between the Bank of England on the one hand and the Treasury and 10 Downing Street on the other over the best way to revive our housing market, our banking system and our economy.

Not much at stake, then.

Fannie, Freddie, Cheshire and Derbyshire

Robert Peston | 14:54 UK time, Sunday, 7 September 2008


After a brief period of calm in the summer, new disturbing evidence has been disclosed today of the weakened condition of financial institutions, both big ones and smaller ones.

The US Government is in effect nationalising North America's two biggest providers of finance for the housing market, Fannie Mae and Freddie Mac.

Their regulator, the Federal Housing Finance Agency, is taking direct control of them under a system known as "conservatorship".

This is an event of profound significance for the global economy, since these two eccentric institutions own or guarantee almost £3000bn of US mortgages.

Banks, including some of the world's most important central banks, have direct and substantial financial exposure to both Fannie and Freddie.

So, given the febrile state of markets across the world, it has become dangerous for doubts to persist about whether these two are viable and would be able to keep up the payments on their massive liabilities.

What's brought Fannie and Freddie to this humiliating impasse?

Well there's the continued decline in the US housing market, the sorriest housing market on the globe (for all the falls in UK house prices).

And then there's the discovery by Morgan Stanley, the investment bank advising the US government, that Freddie's capital resources are smaller than meets the eye.

For the US Treasury, the bailout could turn out to be one of the most expensive financial rescues in history, running to tens of billions of dollars.

Bad news, except perhaps for our own Chancellor of the Exchequer, Alistair Darling - since the Fannie and Freddie rescue costs may well make the potential losses for the taxpayer from Northern Rock seem almost modest (well almost).

Also the US banking debacle gives a bit more credibility to Darling's claims that the UK's economic and financial woes are at least in part the consequence of a global storm, for which he shouldn't be blamed too much.

In fact, while I write, two of our own housing-finance institutions are being steered by the Financial Services Authority into safe harbour, as the Nationwide negotiates to take ownership of two rival building societies, the Cheshire and the Derbyshire.

These are tiny compared with Fannie and Freddie, but they are not trivial in a UK context.

Derbyshire is the UK's ninth largest building society with £7bn of assets and the Cheshire is number 11 with £5bn. Together they have not far off a million customers.

But each has a structural flaw which makes it harder for them to carry on as an independent.

Derbyshire is perhaps a bit too dependent on funding from wholesale financial markets, which since the onset of the credit crunch last summer has been much harder to obtain.

And Cheshire has a commercial property business that is not in the greatest shape.

So although neither of them are bust and there is no reason for their depositors to be unduly alarmed (their savings are safe), the City watchdog, the FSA, wants them under the stewardship of the more robust Nationwide.

The harsh reality of the decline in the housing market means that the members of the Derbyshire and the Cheshire should not expect a windfall or any kind of payment from this deal.

Nor will they get a vote on whether the mergers will go through, as normally happens in consensual deals.

I have learned that the FSA will use its power to force through the transfer of ownership fairly speedily - because any period of uncertainty about the ownership of a bank or building society right now is fraught with risks.

UPDATE 17:31

The scale of the support being provided by the US Government to Fannie Mae and Freddie Mac is quite breathtaking - up to £110bn and the right to own 80 per cent of each of them.

This may not be conventional nationalisation, but its effect is the same.

The two mortgage providers will be under the direct control of their regulator, they will be run by two new chief executives selected by that regulator (both of whom have reasonable track records), and it will be US taxpayers who will have the formal ability to take majority control of them.

What's been announced makes the nationalisation of Northern Rock in the UK look like small beer.

Why the dramatic evasive action?

Well these two provide a good half of all mortgage finance in the US - so when they're in critical condition, there's no possibility of recovery in the ailing US housing market.

And if the US housing market doesn't recover, that prevents the US economy from recovering - and as the boss of HBOS told me (see yesterday's blog), it also prevents the UK economy from getting back on track.

What's more their health is vital to confidence in the global financial system, since more or less every commercial and central bank on the planet has some kind of exposure to them.

So not only are they too big to fail, but they've also got to be returned to some kind of viability for all of us to start to feeling a bit more prosperous again.

'Another 18 months of crunch'

Robert Peston | 00:00 UK time, Saturday, 6 September 2008


The credit crunch won't end till US house prices start to rise again, and that could take 18 months, says the chief executive of HBOS, the UK's leading mortgage provider.

Andy HornbyIn his first ever broadcast interview, Andy Hornby - whose bank owns the Halifax and Bank of Scotland - says British banks will continue to suffer serious difficulties lending to homeowners and companies until they can once again raise significant sums on wholesale financial markets.

He says that two-thirds of wholesale funding traditionally received by UK banks comes from overseas, with the bulk of that coming from the US. And he fears that these US money-market investors won't resume the channelling of money to UK banks for mortgage-lending until US house prices start to recover.

Speaking to me for my series of interviews with business leaders, Leading Questions, Mr Hornby says: "my personal view, for what it's worth, is that it will take 18 months to play through the system because it's going to take 18 months before US house prices have started to rise again - which is what's required for banks to have the confident to start lending again.

It will take a long time to play out."

His assessment implies that there's very little the Government can do to persuade our banks to start providing more normal quantities of loans to homebuyers and businesses.

And since it was the reduction in the availability of credit that precipitated the economic slowdown in the UK, Mr Hornby also implies that there's little the Government can do to restore positive momentum to the economy - although he's adamant that all initiatives are welcome.

A prime cause of the credit crunch, as manifested in the UK, was that - arguably - they became too dependent on selling their mortgages to global investors in the form of mortgage-backed securities: by 2006, such funding provided two-thirds of net new mortgage lending in the UK.

So the sudden boycott of these securities which started in the summer of 2007 deprived our banks of much of the finance they needed - and in the case of Northern Rock, the boycott destroyed its viability, leading eventually to its nationalisation.

The full interview, in which Mr Hornby defends the interest rates being charged by banks for the more limited amount of mortgage-finance they are providing, can be seen this Saturday and Sunday on Leading Questions, on BBC News. You can also click here to see it.

Mr Hornby, who has always kept the lowest profile of all the banks' chief executives, also explains why he didn't resign after the banks' profits slumped and it felt obliged to tap its shareholders for £4bn of new capital.

Cherchez le windfall

Robert Peston | 19:11 UK time, Thursday, 4 September 2008


The Prime Minister may believe he's waving a loaded weapon when urging the power companies to cough up and help those finding it difficult to pay their energy bills.

But what they can see in those nail-chewed fingers is a loaded banana - and they don't feel terribly intimidated by it.

Or to put it another way, they don't believe that there's the faintest chance that he can levy a windfall tax on them.

And - which rather adds to their swagger - nor does the Treasury (although that doesn't impress the army of Labour backbenchers baying for a punitive levy).

What puts the kibosh on the tax is something rather basic: for most providers of gas and electricity to the likes of you and me, there is no windfall.

If they owned vast amounts of oil, gas or even coal which was being extracted within the UK, then there would (arguably) be a very substantial windfall profit that could perhaps be raided by the Exchequer.

But much of this stuff comes from other tax jurisdictions. And, anyway, the diminishing oil and gas that is pumped from the North Sea is already taxed at a very substantial rate.

So those big increases in domestic gas and electricity tariffs announced recently by Centrica, Edf and the rest are hard, in all fairness, to characterise as profiteering, much as we may wish to see them as such. The increments are attempts by those companies to limit falls in their profitability caused by the increase in what they pay for the power they sell.

No windfall: no windfall tax.

But what about the other great wheeze being pondered in Government, that of charging the companies a fat sum for permits to spew CO2 under the European Emissions Trading Scheme?

Well, that's no doddle either.

First, ministers fear there could be a challenge to such a re-writing of the permit distribution system from the European Commission in Brussels.

Second, our eurozone-owned power companies would fight such a levy with all their might, for fear that the French and German governments would introduce copycat charges.

As I say, that's a loaded banana sticking out from Gordon Brown's jacket pocket.

Except for one thing. He believes that the appalling public image of the power companies might persuade them to do the decent thing - as he sees it - and simply volunteer to hand over vast amounts of wonga to provide succour to beleaguered energy consumers.


It's a thought. But the Government's great announcement on its partnership with the power companies to tackle fuel poverty was supposed to happen this week and has been postponed.

And although it's not officially dead, ministers and power-company execs are cautioning me that they don't know when - or even whether - a deal will be struck.

Housing hazards

Robert Peston | 14:12 UK time, Tuesday, 2 September 2008


Probably the best things that can be said about the increase in the stamp duty threshold are:

1) that it removes the uncertainty about the costs of buying a property which has been a blight on the housing market (as if another one were needed) since the chancellor's notorious Today programme interview earlier in the summer;

2) that it will help beleaguered housebuilders rebuild their profit margins, since some will simply increase their selling prices by 1%;

3) that the cost to the taxpayer will be minimal, because property transactions in the current fiscal year are running at a fraction of what the Treasury expected (or to put it another way, the public finances will be horrible this year, partly because property-related tax revenues are collapsing).

But otherwise, most economists and bankers see the reform as a bit of a yawn-inducer, a non-event.

How so?

Houses for saleWell a 1% saving for prospective purchasers is neither here nor there when they daily hear prognostications from credible forecasters that house prices may fall a further 15% in the coming year.

Here's the big point: the tax change is totally irrelevant to what is driving the generalised fall in house prices, which is that banks are much less willing to lend than they were and are no longer offering super-cheap fixed rate loans.

Why was the number of approvals for house purchase down by a staggering 71% year-on-year in July? Did it have anything much to do with stamp duty?


The incredibly shrinking housing market and squeeze on house prices is the consequence of banks' scything their balance sheets and rebuilding their capital ratios. Or to translate, they are lending less and demanding vastly bigger deposits as a condition of the loans they will provide.

In that context, today's package of subsidies from the Communities and Local Government Department for overstretched borrowers and first-time buyers may do a little to lift the gloom at the bottom end of the market.

That said, although it may provide priceless succour for those who fear they may be thrown on to the streets, it can't possibly change the negative trend in the trillion-pound housing market.

How could it do so, given that the Treasury is providing no new money to the communities department?

If the cause of the problem is that the banks are lending too little, any solution would need to encourage them to lend more.

And that in turn would probably require an incentive for global investors to deliver the precious moolah to banks which in turn could be transmitted to homebuyers in the form of mortgages.

At the moment, those global investors are boycotting our mortgage market, for the blindingly obvious reason that it doesn't look too healthy.

Which is why the Treasury is looking at providing some kind of guarantee to investors - which could just be other banks - that they won't lose a bundle if they finance our banks to provide mortgages.

It would be the kind of evasive action that can't be done lightly. It could, for example, increase the national debt by tens of billions of pounds.

Bank of EnglandAnd the governor of the Bank of England has already said he hates the idea, because he fears it could encourage reckless lending of the sort that got us into this mess in the first place.

But here's why Mervyn King's objection may be theological rather than practical: lending to our banks is already underwritten by the Treasury, in the sense that in these febrile times it dare not allow bank depositors to fear that they could lose a bean by keeping their funds in the smaller more vulnerable banks.

And if the fall in house prices were to gather momentum, the consequence for spending, investment, employment and the health of our banks could be quite troubling.

So here's the important calculation for the Treasury: should it temporarily underwrite the mortgage market, to pre-empt the risk that otherwise it will end up as the owner of more banks than just Northern Rock?

UPDATE, 17:18PM: Ministers acknowledge that the widespread falls in house prices are unlikely to be stemmed.

The tax change, and a package of housing market subsidies announced by the communities department, have two main aims: to help first time buyers who have been forced out of the housing market by banks' insistence that they put down a substantial deposit; and to help financial stretched families starve off painful reposession.

But given the Treasury's acknowledgement that it can't and won't stop house prices decreasing, should the Government be encouraging the young and homeless to take a step on to the housing ladder at this juncture?

Wouldn't that be putting them on the fastest possible route to lose money?

Wouldn't it be more rational to rent right now, and wait for the market to stabilise before diving in?

So, after the unpropertied have followed the Prime Minister's implicit advice and have bought, will they then expect him to make good any future capital losses they suffer?

The football bubble

Robert Peston | 08:18 UK time, Tuesday, 2 September 2008


What's happening in the Premier League is a microcosm of the bubble that precipitated the credit crunch.

Berbatov RobinhoThe massive financial surpluses being accumulated in the fast-growing, exporting nations of the Middle East. Russia and Asia need to be spent, lent or invested.

For years the transfer to the West of these surpluses was in part responsible for all that ludicrously cheap liquidity or cash which put dangerous rocket-fuel into our housing and property markets.

And to state the bloomin' obvious, that boom led to a bust that has touched all of us.

But there's one related boom still raging - at the top end of the football market.

Yesterday's farce of the Berbatov and Robinho transfers shows that the bubble in the price of top-class players continues to be pumped up, to perhaps dangerous levels.

The desperate last-minute negotiations for the Bulgar and the Brazilian are not redolent of a rational market.

It's simply that there's a new big spender in town, this time one from Abu Dhabi, for whom £30m is the kind of loose change that can be lost with impunity down the back of the sofa.

Just like what happened in the UK and US markets for property and companies, the price of these ball-juggling assets is being driven up by the sheer weight of money chasing them, rather than by rational analysis of the long-term rewards to be had from them.

And when prices soar on the back of cash-fuelled emotion, the risk increases exponentially that bust will follow boom. Think dotcom, or subprime or (going back a few years) tulips.

This frenzied trade in the human capital is also undermining the basic economics of the game - because the spend-spend-spend imperative on players makes it well-nigh impossible for a top club to make a conventional profit.

In that context, Arsenal's performance this year could be a watershed, in that it continues to boycott the super-pedigree cattle market, and retains a quaint old-fashioned view that the club should stay in the black.

Arsenal playersBut if the Arsenal were to win nothing for a fourth consecutive year, its conservatism would be harder to sustain.

The problem for Arsenal is that although it may not wish to be a crazy buyer, retaining its existing assets - its players - becomes harder and harder. Because the assets can walk to the clubs where they soak in Krug after each game.

In this context, the relevance of the Berbatov deal is as a further demonstration of how power has been transferred from even a substantial club like Spurs to an individual player and his agent.

A Spurs director was not far from tears of frustration when he described to me how Berbatov's long-term contract was only useful for the club in generating a spectacular fee, but meant nothing in respect of retaining his services.

The only ties that bind seem to be pay deals that run to eight figures. And for that to be sustainable, all our major clubs would have to owned by the plutocrats and princelings of the new economic superpowers.

Even the US sports billionaires at Man Utd and Liverpool wouldn't have deep enough pockets.

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