Letter from London - Big Bang Bugs British Banks

LONDON - It has come to this. London's Big Bang was to open up UK financial markets to stop the grousing by Oxford-Cambridge graduates about how much more money their Wall Street cousins earned. But opening up the UK markets also allowed in the U.S. subprime-CDO-CDS virus that laid low many U.S. institutions and now has more UK victims. Europe's more regulated financial sector has been relatively immune to the disease.

How the right and the left do converge in such a crisis. Dubya's administration with Phil Gramm's leadership was engaged in a methodical deregulation of the financial markets. But it showed no hesitation about swiftly seizing the commanding heights of the mortgage lending and investment banking industries.

In Britain, Gordon Brown's Labour Party - ideologically far more prepared to turn its banks into government bureaucracies - delayed taking action but is now following in Uncle Sam's tracks. The Financial Times calls the bank bailout a "part-nationalization".

Newspaper headlines this morning focus on a £50 billion UK bank bailout. The Times, Daily Mail, Telegraph and Independent have major headlines, all explaining that the number is an estimate of an initial infusion of capital by H.M. Government to buy equity primarily in three major banks - Royal Bank of Scotland, Lloyds TSB and Barclays. A fourth bank, the Halifax Bank of Scotland, is also involved because it is in the process of being absorbed into Lloyds. (The Royal Bank of Scotland has already absorbed National Westminster.)

The Evening Standard, however, perhaps because it has a later deadline, reports that the bailout is for much more, £500 billion or about $870 billion. The larger number is huge for an economy that is substantially smaller than that of the United States. It is also more realistic, because it includes £50 billion to guarantee bank bond issues, £200 billion for short-term lending and another £50 billion for recapitalization.

Besides the big banks that have been huddling with the Chancellor, four other banks are mentioned in the Evening Standard story - Abbey, Nationwide, HSBC and Standard Chartered. The list is still "in formation" as HSBC, for example, isn't convinced that it wants or needs the government's money.

The complaints over here are similar to the ones aired in the United States, except that in addition Her Majesty's Government is being called dilatory. Simon Jenkins of the Guardian describes as "dithering" by Brown's Chancellor Alistair Darling as "dithering" and Parliament as "useless" - postponing action because of a schedule "fixed by the grouse-shooting season." London traders are described by the Evening Standard as calling the new act "Too little, too late." Alistair Osborne of the Daily Telegraph headlines his story: "Action at last - but is it too late?"

Most of the commentary, of which there is much, focuses on the control that the government will exercise and the taxpayer perspective. The Daily Mail says the banks will "fall under state control, the biggest nationalization of modern times."A typical comment is by Alex Brummer, who says that "the heavy hand of government" will exercise "ever more control" over the banks.

The IMF is reportedly about to release a projection that the UK is the "biggest casualty of the world downturn", with bank losses reaching $1.4 trillion and the GDP growth turning negative in 2009 for both the United States and Britain. Brits are asking the same question as Main Street USA - "What do we get for our blank check?"

Armageddon-friendly theorists go further and predict that the financial crisis will be the death knell for the euro and some suggest raises questions even about the future of the EU itself.

DOWN DOWS | Cognitive Dissonance 2

July 11, 2008–On Nov. 8 last year, in DOWN DOWS | Cognitive Dissonance  and then on  Nov. 8 in  Huffington Post, I noted that Bob Janjuah of the Royal Bank of Scotland had raised the upper end of his estimate of cumulative subprime write downs. His estimate was $500 billion at a time when losses of just $50 billion were acknowledged by institutions. Now Janjuah looks like an optimist:

1. Bridgewater Associates, the world's second-largest hedge fund, has estimated likely asset writedowns at $1.6 trillion, i.e., a 6 percent overvaluation of $26.6 trillion of risky credit-based U.S. assets (mortgages, credit receivables and credit-card receivables). Some bankruptcies are predicted.

2. David Rosenberg, Merrill's Chief North American Economist, argues in a July slide show that more bad news is in store:
- A recession? We're in it. Just a question of how bad it gets and for how long.
- Asset values? Not yet priced low enough to reflect the recession.
- Housing prices? Could fall another 20 percent.
He therefore believes that while stagflation is the problem today, tomorrow it will be deflation and Fed policy must therefore remain accommodative.

Recent declines in the Dow are closing the disconnect I noted on Nov. 8 between the debt and equity markets. But the months ahead will be challenging for private investors and government officials at all levels.

BANK CRISIS 2008 | After Bear Stearns Do We Need Brady Bonds?

March 18, 2008–The Fed's intervention in the Bear Stearns distress was presaged on November 8, 2007 when bank announcements of billion-dollar writeoffs were being announced with an air of finality while analysts like Bob Janjuah of the Royal Bank of Scotland were saying that the losses would soar to $250-$500 billion.

That November day, Chairman Bernanke told Congress to expect "temporary" slower growth and higher inflation.

How long is temporary? The overnight 97.5 percent cut in Bear Stearns's valuation (from $80/share book to $2/share sale price) may hasten whatever markdowns and recapitalizations are still needed in other financial institutions. Brady Bonds could help unfreeze the credit markets.

(More: John Tepper Marlin, Huffington Post, After Bear Stearns: Brady Bonds.)

SUBPRIME LOANS | U.S. Problems Exported

Nov. 11, 2007–Foreigners holding U.S. securities are losing money because of the decline in the value of the dollar. Now, it seems, many of them may find they are also losing money on the securities themselves.

Barclays and the Royal Bank of Scotland appear to be caught in the web of Collateralized Debt Obligations. It was an RBS analyst, previously cited, who put the magnitude of the loss from subprime debt at $250-$500 billion. A Deutschebank analyst's forecast is more precise at $300-$400 billion. These estimates are larger than the S&L losses in the 1980s. This time round, the rest of the world will be sharing the pain.

I am using several public sources to generate a side-by-side comparison of the Savings and Loans and subprime crises. It may be found here. This is a work in progress and will be updated.

BUBBLE | Cognitive Dissonance - Equity- vs. Fixed-Income Markets

My point on October 19 about the relevance of cognitive dissonance – which John Tierney has since written about in the NY Times in a non-Wall Street context – continues to apply through two more seriously down Dows, the second of which was the 361-point decline yesterday.

The cognitive dissonance is between signals that securitized subprime losses and other bad news are fully written off/discounted and other signals suggesting that they are not. Or, as a Wall Street trader put it to me at noontime yesterday as we were listening to Fed Governor Kevin Warsh: "The equity markets have been saying one thing and the fixed-income markets another. They can't both be right." Traders make their living by surgically eliminating their preconceptions based on new truth and making swift moves in advance of other investors.

The fixed-income markets were at their most bearish yesterday since August, while equity investors have mostly been hanging on in the hope that the latest Dow drop is the last. Professionals are more wary of "catching a falling knife" by believing that what looks like the end of the bad news really is. I remember that in the summer of 2000, after the disastrous March downfall of the dotcoms, someone was attempting to sell shares in a bottom-fishing hedge fund that would pick up dotcom bargains. Well, the dotcom basement had a sub-basement and even a level B and C below that, as we found out in November 2000 if not before.

The fast-growing Royal Bank of Scotland, fifth-largest bank in the world, takes a surprisingly dim view of how much more in the way of losses remains to be declared. Its chief credit analyst, Bob Janjuah, estimates subprime losses and new accounting requirements (FASB 157, effective Nov. 15, which make it hard to mark Level 3 assets to "make-believe") will bring cumulative writedowns in the $250-$500 billion range. Up till now we have seen at most $50 billion acknowledged. So either RBS exaggerates, or the capital markets have further significant adjustments to make.