Monday, 6 October 2008
Big Banks OK? - None too big to fail?! Er, No?!
When markets move in an hour or a day up or down by percentages normally experienced over many months you know you're lost, VaR and volatility risk models useless, broken. For a decade, anytime walking past the Old Lady of Threadneedle Street or the Stock Exchange I'd regret the loss of their powers over the rest of The City. No longer. Not since 1926 when 200 British banks failed, has the Bank of England's role been more critical.
This morning RBS is -31%, Barclays -13% and Lloyds -12%. Barclays opened at -15% and Lloyds -20%, based on speculation that the government is considering the Warren Buffet solution of injecting capital into banks in return for equity stakes and so this is being rumoured as massive rights issue dilutions. The rule is "buy on fact, sell on rumour!" (Barclays are anxiously denying the rumour that it has asked UK Government for financial support - which kills the TARP idea and leaves us with the Buffett profit-way!) So everyone's selling until after lunch maybe? (And hedge funds are all straining at their leashes; amazingly they are officially complaining to Government to be allowed to resume short-selling, complaining the options market is too expensive!)
Backed by UK Government and other EU governments saying that from now on no big bank must be allowed to fail. This brave stance is being tested to destruction (markets do that). More than that, the game is now to save countries' financial sectors, perhaps even beginning with the UK - why not, since the £ is going down. It is a battle of wills, hard cash and ideologies; if banks cannot save themselves and in the global scale of the present turbulence, it does not seem at all impossible for the UK big 4/5 banks to be taken into majority public ownership, or at least one third?
What is the global scale against which this may become a puny if necessary and desperate decision? Yesterday saw sell-offs led by recession fears; today the sell-offs are led by banks. Now, the very biggest UK banks are at imminent risk, and others in Europe. Yesterday world equity stocks lost about $2tn (equal to half of all banks' tier 1 capital), of which US $0.5tn (after falling $1tn and then recovering half of this in the last hour), UK lost $0.1tn, Rest of Europe $0.2tn, Japan $0.15tn (and the same again in the first 15 minutes on Tokyo's opening this morning) and so on, and probably the same again today, why not? All told about $8tn has evaporated (-14%) from the world's stock markets since last Christmas, a quarter of that yesterday alone, but it might be $10tn by tonight, and then again it could be bounce up tomorrow or just down then up each day until we stop playing markets at the weekend when the central bankers and big banks get together to decide how to save this or that systemically big bank, and maybe this weekend there will be half a dozen major banks' balance sheets on the operating table? This is high finance high politics - nerve-wracking and ruthless.(Fortis was sold for €14.5bn well below book value its and minus its toxic assets also written down from €44bn to €10bn!).
Stock market investors and brokers are very febrile, jaded, cynical, no wonder, reacting instantly to every cage-rattle, win some lose some but keep on trading until maybe even big countries follow Iceland's example and stop the trading in banks' shares? The $ is going up and funds are flowing from Europe to the USA.
Slower moving events have comparable scale. Residential and commercial real estate values have retreated globally by roughly $8tn also. World cash earnings and profits (GDP) growth has slowed by maybe $2.5tn if growth is still positive for the year which seems unlikely? US and UK and other Anglo-saxon economies are in recession already. It may take months yet before official figures confirm this. But, adding in debt market write-downs it is not hard to conclude that about $15tn of active credit collateral supporting secured and unsecured bank lending has gone, and will not return for some time, not for 2-3 years.
I estimate that the world's banks have about $100tn in assets (loans) outstanding originally secured by about $60tn of financial assets and property values (including RMBS and CMBS etc.) the prices of which have fallen by maybe one third. The world's banks (financial system) have about $60tn in private and business deposits and bank bonds' holders. There remains $70tn in property and about $40tn in equities, $10tn in government bonds plus maybe $6tn non-junk corporate bonds. If 10% of all these convert to new bank collateral (only $8tn), which would be a stunning result, then on top of about $0.5tn in lost equity, the banks need to find another $1tn in new capital. But, most of this need is concentrated in USA and Europe. The banks need to replenish about one third of their "own capital" and that therefore is the % of banks that governments are looking at ending up owning. The equity markets are roughly discounting that possibility already by knocking banks' shares down by a third over 2 days!