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Archives for November 2009

Dubai: Wholly avoidable crisis

Robert Peston | 10:18 UK time, Monday, 30 November 2009


Few, I think, would now deny that last weeks tremors in markets - prompted by Dubai World's statement that it would not be keeping up the payments on its debts - were both overdone and avoidable.

It was no secret that of all the world's property bubbles, one of the very bubbliest had been in Dubai - or that the bubble had been pricked a year ago.

Even the International Monetary Fund (in its latest report on the prospects for the global economy) noticed that the United Arab Emirates had suffered the third-worst fall in house prices during the first three months of this year of any country (a fall of nudging 40%; only Latvia and Estonia suffered worse drops).

Dubai was not an accident waiting to happen: it had already happened, locally at least.

So the financial difficulties of one of the city state's most ambitious developers, Dubai World and its Nakheel subsidiary, were a consequence of known facts.

However, there were three big things that were not known:

• whether the putative guarantee from deep-pocketed Abu Dhabi for Dubai's state-linked businesses was real or imaginary;
• the potential size of impaired loans to Dubai interests;
• the identities of those exposed to Dubai, through loans and other financial commitments.

What shook the confidence of banks and investors more-or-less everywhere last week was that neither the United Arab Emirates nor ailing Dubai felt able to answer these questions last week when Dubai World announced its debt moratorium.

So fear and rumour took hold: equity markets dropped; there was a flight to supposedly safe assets, such as US Treasuries; and the price of insuring the debt of heavily indebted nations rose sharply, just in case Dubai was the first of a series of dominoes.

Here's the pertinent point: we had a bit worse than a dry run last year of the damage that ignorance can cause.

Think about the havoc wreaked last October by the uncertainty over financial firms' exposure to Lehman when it went down.

Remember the mess caused by the lack of clarity about whether the debt of Fannie Mae and Freddie Mac, the US mortgage institutions, were really liabilities of the US federal government.

Which is why some would say that there's absolutely no excuse for the failure of the UAE and Dubai authorities to pre-empt the panic by shining a light on the magnitude of the risks being incurred by creditors to this indebted emirate, including early and unambiguous clarification of what support would be given by Abu Dhabi and the central bank.

Others might also question why the IMF was also - seemingly - caught on the back foot.

To state the obvious, we are a long way from having the kind of global early warning and prophylactic system in place that can minimise the impact of financial shocks.

DubaiAnyway, the UAE's central bank said somewhat belatedly - yesterday morning - that it will provide emergency loans to local banks and branches of overseas ones, so that none of them falls over if anxious depositors and creditors should withdraw funds.

But, inevitably, stock markets in the UAE have tumbled very sharply this morning.

This was largely catch-up, however, since they were shut on Thursday and Friday for the Eid al-Adha holiday while London, Tokyo and New York were being bashed.

Outside of the Middle East, in Asia and Europe, investors have regained a bit of their appetite for risks: share prices have risen a little; US Treasuries are falling gently.

Or to put it another way, more by accident than by design of the Dubai or global authorities, it's become clear that contagion from Dubai is likely to be fairly limited.

That said, we cannot and should not slumber soundly: we can be pretty certain there will be other financial shocks from assorted parts of the global financial economy in the weeks and months ahead.

And if the global or local authorities lack plans for evasive action on those occasions, well that would surely be scandalous (you might say).

British banks and Dubai

Robert Peston | 17:06 UK time, Friday, 27 November 2009


As Stephanie Flanders has pointed out, there is no serious direct threat to the health of the global financial system from the inability of Dubai World to keep up the payments on $22bn of debt.

Even if all these loans had to be written off - and it's entirely possible that write-offs will be zero - those losses can be absorbed by banks and other lenders.


In the UK, for example, the Financial Services Authority built into its estimates of how much capital our banks need to raise the very high probability that loans to Dubai would go bad.

To provide a bit of context, Royal Bank of Scotland has raised considerably more equity capital - via the unconventional route of the Treasury's Asset Protection Scheme - than the total value of all the debt whose value has been impaired by Dubai World's announcement of a standstill on payments.

So too - via its rights issue and debt conversion - has Lloyds.

That said, British banks are more exposed than most to the United Arab Emirates, of which Dubai is the economy built on sand, or rather excessive debt.

According to the authoritative statistics of the Bank for International Settlements, UK banks have lent around $50bn to the UAE, more than 40% of all bank lending to the UAE.

So Royal Bank of Scotland, Barclays, Standard Chartered and HSBC would wince in the event that there was contagion from Dubai World to other UAE borrowers. But the pain would be bearable.

The importance of the Dubai sandstorm is psychological and emotional.

It reminds investors that the world's rich countries are only mid-way through the workout - the rescheduling and repayment - of their excessive debts.

And also that there are three big looming uncertainties that have to be resolved before we can say that its business as usual:

1) How will the world's banks cope as they are weaned off the $15 trillion dollars of exceptional assistance they have been provided by us, by taxpayers (in the form of loans, guarantees and investment)?

2) Where will asset prices - property, shares and bonds - settle, as and when central banks cease creating new money and raise interest rates to more normal levels?

3) Will heavily indebted countries - like Dubai, or Greece, or Ireland, or even the UK - reduce their debts fast enough to retain the confidence of creditors, but not so fast as to precipitate further recessions?

Some will be tempted to see Dubai and the UAE as the canary in the coalmine.

That will not please the richest of the Emirates, Abu Dhabi - that's not a badge it would wish to wear.

Which is why British officials are convinced that within the next few days, there will be a statement from Abu Dhabi that it will honour the external debts of Dubai.

I assume their optimism is more than wishful thinking.

Why did Bank of England keep shtoom?

Robert Peston | 18:23 UK time, Tuesday, 24 November 2009


I am still away, sorting that family problem I have mentioned before, but I could not resist making a couple of points about the Bank of England's clandestine emergency loans to HBOS and Royal Bank of Scotland.

The first and obvious question is why on earth the Bank, Treasury and FSA thought it was a good idea to keep the £61.6bn of lending secret.

It's not as though they hadn't publicly stated at precisely the time the loans were being given that both banks were effectively bust.

On 8 October and again on 13 October of last year, the Treasury publicly announced - with its unprecedented package of support measures worth around half a trillion pounds - that the entire British banking system was in dire straits.

As for RBS and HBOS, they were identified by the authorities as kaput as commercial operations - because we as taxpayers had to inject more than £30bn of capital into them.

Against that backdrop, it might actually have been reassuring to depositors, investors and taxpayers to have had confirmation that the Bank of England was providing loans to replace private-sector finance that was melting away from RBS and HBOS.

Mervyn KingHowever, as often happens, the authorities - led on this occasion by Mervyn King, the Governor of the Bank of England - were fighting an old war, not the one actually being waged.

They were so bruised by the run on Northern Rock, which began after I disclosed a year earlier that the Rock had asked for emergency loans from the Bank, that they felt that they had to take advantage of new legislative powers to keep such loans secret.

But there was a big difference between the Rock on the one hand and RBS and Lloyds on the other: the Rock and its depositors had received no pledges that the bank would not be permitted to collapse when the emergency loan was confirmed. The Chancellor, Governor and head of the FSA all refused to promise that the Rock's depositors would not lose a penny.

But a year later they all showed in word and deed that HBOS and RBS were too big and important to fail.

So keeping secret that additional Bank of England support will seem fatuous to many.

Has the cloak-and-dagger performance done any serious damage?

Well, some shareholders in Lloyds will have their fears reinforced that they weren't in full possession of the facts in approving their banks' takeover of HBOS - although it's unclear whether those Lloyds owners who want redress will have their claims strengthened in a legal sense.

Also I am not sure that this example of covert ops by the Bank of England will promote financial stability in a long-term sense.

There will be many in the market who will now wonder what other horrors the Bank of England feels it can't unveil "devant les enfants".

Update 09:35 GMT, 25 November: A number of your comments are giving me pause for thought about whether I am being either naive or too knowing in querying whether the Bank of England was being rational in cloaking those emergency loans to HBOS and RBS.

It is true that, last October, it was of little interest to me whether or not the Bank of England was providing short-term emergency funding to RBS and HBOS.

How so?

Well, as I have said, it's because we had official confirmation from the Treasury, Bank of England and FSA that they were more-or-less bust - but were being propped up by the state.

Let's just take one item of taxpayer support announced at the time, the Credit Guarantee Scheme.

This was - in effect - a promise made on 8 October by the Treasury to lend £250bn to the banks.

In that context, £60bn of very short-term emergency funding by the Bank of England - which was necessary until the banks could complete technical arrangements to issue funds under the CGS - doesn't seem that significant.

Also, the Bank of England increased to £200bn the exceptional facility it had created allowing the banks to swap mortgages they had already provided for Treasury bills, the equivalent of cash.

So I have to say that - at the time - I really didn't give a fig whether the Bank of England was providing emergency bridging loans, until the effect of these other taxpayer-backed schemes kicked in.

We as taxpayers were up to our necks in financial commitments to HBOS and RBS. In that sense, surely it was irrelevant that they were maxing out their credit cards with the Bank of England until they could take advantage of the new overdraft facility at the Treasury?

Well, the truth is - as some of you have implied - that perhaps I am making the silly mistake of assuming that markets would have taken this cool and rational view.

There was a mood of utter irrational hysteria among banks and investors at the time.

And I guess there's a risk that the formal disclosure that financial institutions were calling in their loans to HBOS and RBS on such a colossal scale - which would have been the unmissable implication of the Bank of England lending tens of billions to them - would have fomented even greater panic.

So perhaps the Bank of England was right to keep shtoom (or perhaps "schtum", as my Yiddish coach has pointed out) at the moment of highest anxiety.

But many would say that there was no sound reason to keep the secret for quite as long as it has done.

The Treasury hedge fund

Robert Peston | 09:49 UK time, Tuesday, 3 November 2009


HM Treasury today becomes perhaps the biggest hedge fund in the UK: it is investing £25.5bn in Royal Bank of Scotland shares and £5.7bn in Lloyds shares, financed almost exclusively by borrowing.

RBS and Lloyds logosIt's probably quite good business.

If we're past the nadir for the economy and for bank shares - and that's a fair bet - it's not a bad punt to borrow at an average interest rate of around 3% (by selling new gilt-edged stock with maturities of five years or ten years) to invest in assets with substantial potential upside.

I'm not sure that I'd recommend that the government speculate its way out of its debt problem by taking further stock-market punts, but there is a delicious irony that economic and financial woes caused by banks gearing up their balance sheets in the boom years are being solved by HM Treasury now gearing up the public-sector balance sheet.

Of course, the chancellor would never concede that he's become a hedge-fund manager.

His motive for deploying taxpayers' funds in this way is to shore up these two banks.

Even though the outlook for both of them is way better than it was six months ago, they're still chronically short of capital.

The weakness of RBS is the most terrible indictment of its previous management and board.

Only with the most complex and delicate of financial engineering has it escaped the fate of being 100% nationalised.

Because on top of the £25.5bn of new capital - provided by you, me and 30 million other British taxpayers - the state is also (as I pointed out yesterday) selling it catastrophe insurance through the revised Government Asset Protection Scheme (Gaps) and promising to inject a further £8bn of capital were there to be a further calamity of biblical proportions for the banks.

Here's how to see all this: Royal Bank is being forced to raise sufficient capital to protect itself against the losses that are most likely to materialise over the coming few years; and it has a contingency plan just in case the worst were to happen.

As for Lloyds, it too became perilously fragile - although compared to poor old RBS, it looks a model of prudence.

Lloyds' requirement for £21bn of additional capital is one of the great humiliations in the history of banking.

But the bank has retained, perhaps, just a scintilla of dignity, since it is raising most of this capital from the private sector, rather than from taxpayers.

Here's what may strike a few of you as odd: Lloyds is paying a staggering, unprecedented, reputation-destroying £2.5bn fee to the Treasury for being propped up by the state over the past few months; and (like the management of RBS) the executive management of Lloyds' board has only agreed to defer their bonuses for their performance during the past appalling year until 2012.

To be clear, it was the current top team at Lloyds that (unlike their opposite numbers at Royal Bank) were the architects of the bank's woes. Which is why some might say that cancelling bonuses would perhaps be more appropriate than postponing them.

RBS and Lloyds re-made by Europe

Robert Peston | 14:20 UK time, Monday, 2 November 2009


I am still away sorting out my family stuff. But I could not let the most significant ever forced reconstruction of the British banking industry go by (one of the most important ordained reconstructions of any UK industry) without sticking my oar in.

So here are a few thoughts.

There are three main elements to what will be announced tomorrow: divestments of banking operations by the Royal Bank of Scotland and Lloyds to stimulate competition; divestments by the Royal Bank of Scotland to punish it for taking so much state aid; measures to strengthen both Royal Bank and Lloyds.

First, Royal Bank and Lloyds will be obliged to create two new banks out of their existing sprawling networks which they will commit to sell within four years to promote competition.

One important thing to note is that the British government can take none of the credit (or the blame, if that were how you felt about it) for this attempt to provide a bit more choice to consumers and small businesses.

Neelie KroesThis forced fragmentation of our banks is being ordered by the European Commission - and more specifically by its competition bit under Neelie Kroes.

It will be fascinating to see if either the Treasury or the Tories give her credit for actions which - they both claim - are consistent their own ambitions.

In the case of RBS, it will create a new small-business bank - which it will endow with the historic "Williams & Glyn" brand name - by hiving off more than 300 branches, many of them in the north-west of England.

This will reduce RBS's market share in small-business banking by around five percentage points, from about 30%.

And there will be an analogous disposal of a retail bank, under the brand Cheltenham & Gloucester, by Lloyds.

Then there'll be the smack for RBS.

Ms Kroes has decided that RBS has to be made an example of for taking so many foolish risks during the boom years that it now needs a mind-boggling amount of support from taxpayers.

RBS only learned the horrid truth in the past week.

So, to discourage banks in future from being so reckless, she is insisting that RBS flog off all its insurance operations (which go under the Churchill and Direct Line brands), plus a bit of investment banking, plus a bit of retail services.

But RBS shouldn't be too badly damaged by the break-up, because it will have four to five years to flog these assets - which means they should fetch a decent price, not a knockdown, fire-sale price.

Finally there are the measures to strengthen what's left of RBS and Lloyds from the harm of potential future losses.

Both are being forced by the City watchdog, the Financial Services Authority, to increase their respective stocks of core "tier one" capital - largely pure equity - to comfortably over 8% of risk-weighted assets (10% or so).

This is four times the minimum they were obliged to hold before the crunch - which shows, arguably, that the FSA and overseas regulators were absurdly lax during the boom years.

RBS will again turn to taxpayers to help reinforce its buffer against future losses on loans and future losses.

It will raise some £25bn of new capital, most of it from the Treasury - which will lift the state's shareholding in RBS from 70% to a maximum of 84%.

But to maintain a fig leaf of commercial independence, the Treasury will promise it will never exercise voting rights exceeding 75% of all voting shares (which will allow RBS to keep its stock-market listing).

It's not all bad news for private-sector shareholders in RBS. Although this is a weak bank, it's less weak than it expected to be at this stage of the recession.

So it needs less insurance from the Treasury against future losses on loans and investments - in the form of the so-called Government Asset Protection Scheme (Gaps) - than it originally negotiated.

Under the revised Gaps, it'll pay an annual fee of around £1bn a year for the equivalent of catastrophe insurance - which will be cancellable at any time. This will cover it for future losses on loans that exceed £40bn (up from £20bn - ignoring losses already incurred - under the original deal).

The terms are better for shareholders in a second sense: RBS will be able to use its recent losses to reduce future tax bills.

As for Lloyds, it will probably escape Gaps altogether by raising comfortably more than £20bn of extra equity capital from shareholders and from financial institutions that have already provided it with other, less desirable forms of capital.

In other words, some of this additional equity capital will be genuinely new money, whereas some will be a conversion of existing capital that doesn't provide the desired degree of protection.

In steering clear of Gaps, Lloyds' dependence on the state will stay as it is (that is a 43% stake for taxpayers plus assorted taxpayer-backed loans and guarantees - so still very substantial).

But the chancellor has extracted a huge price for the implicit support Lloyds has received from the promise of Gaps over the past few months.

In return for underwriting the bank's survival since the beginning of this year, Lloyds will give a £2.5bn discount to taxpayers on the subscription of new capital.

This represents another massive transfer of wealth from Lloyds' private-sector shareholders to the state.

I guess those shareholders will think the price is worth paying to stem the creeping nationalisation of Lloyds. But it is quite a price.

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