Tony Walker is not a big name in the international banking world, or even
British finance.
But Walker could just be a saviour for scores of small businesses in the north
of England. From an imposing stone office block in the Yorkshire town of
Skipton, Walker, a 62-year-old former investment banker, is hoping to throw
a lifeline to small companies as they face a crippling credit squeeze that
could threaten their future.
Last week, Skipton Business Finance, the subsidiary of Skipton building
society where Walker is managing director, pledged to offer cut-price loans
totalling £25m at Bank rate until the end of March.
“You can’t pick up the paper without reading about the credit crunch. When the
wholesale markets are constipated and people are unsure about the risks,
they stop lending. That’s happened. There is capital out there and we are
prepared to prove it,” said Walker.
Skipton and the fortunes of small entrepreneurs may seem a world away from the
woes of Wall Street firms and frantic investment bankers in their glittering
skyscrapers.
But the shockwaves from the freeze in credit markets, which started in August,
have spread. Large banks have written off a mammoth $50 billion (£24
billion) of losses linked to credit markets. Others were plunged into crisis
– from Northern Rock to America’s biggest mortgage lender Countrywide
Financial to Germany’s IKB.
The crunch has claimed high-profile scalps, including the chief executives of
Merrill Lynch and Citi and, last week, the most powerful woman on Wall
Street – Zoe Cruz, co-president of the investment bank Morgan Stanley.
In September, many bankers hoped the summer credit freeze would be a temporary
financial crisis with limited consequences for the wider economy. But the
events of the past few weeks suggest the crisis is turning into something
far more damaging.
How long will it last and how far will it reach?
“We don’t really know the answer to so many questions. We don’t know how deep
the US housing downturn will be and how long it will last; we don’t know the
ripple effect to the UK or other housing markets. We don’t know the
implications for – and how much needs to be written off by – various
financial institutions,” said Jack Malvey, Lehman Brothers’ global
fixed-income strategist, a highly experienced banker who colleagues say has
the brain power of a super-computer.
Suddenly the mood has darkened. Just when bankers and investors were hoping
the worst was over, a second devastating wave of writedowns from major banks
has rocked confidence. In recent weeks, Citi announced it would write down a
further $6.4 billion in losses related to the sub-prime mortgage crisis.
Merrill has also revealed more losses, while HSBC last week said it would
take $45 billion back onto its balance sheet by rescuing two
structured-investment vehicles. Last month Barclays wrote off $1.3 billion.
More pain looks inevitable. Analysts expect Citi to be hit with a further $15
billion of writedowns. Investors will be nervously scrutinising a Royal Bank
of Scotland trading statement this Thursday when the bank is expected to
reveal sub-prime-related losses of more than £1 billion. Goldman Sachs
analysts have estimated that the total sub-prime-linked losses could reach a
whopping $500 billion – far higher than Federal Reserve chairman Ben
Bernanke’s initial estimate of $50 billion, later revised to $150 billion.
To add to the gloom there are mounting fears that the problems could engulf
other types of American debt – credit cards, car finance and unsecured loans.
Part of the problem is the financial innovation of recent years. Mortgages and
other forms of debt were sliced and diced, packaged up and sold on to
investors around the globe.
“What has happened is that the risk has been spread so far and wide that
no-one really knows where the pain is being taken. The financial bombs just
keep going off,” said one senior investment banker.
Unsurprisingly, there are suspicions that asset managers and insurance
companies could be sitting on huge losses. The climate of fear has caused
bank shares to get hammered on fears about funding.
This has made banks even more nervous about lending to each other. Last week,
London’s three-month Libor rate, set for inter-bank loans, moved to levels
that were last seen in mid-September.
“There will be wave after wave of problems. This has barely started and it is
going to get more bloody,” said one senior UK fund manager. IF bankers are
worried, so are those who run the economy. Bernanke, whose tenure as Fed
chairman in succession to Alan Greenspan has been stormy, warned that “the
outlook has also been importantly affected over the past month by renewed
turbulence in financial markets”.
The apparent improvement in conditions in September and October had been
partly reversed, leading to “a decline in equity values, a widening of risk
spreads for many credit products – not only those related to housing – and
increased short-term funding pressures”.
The Fed, America’s central bank, needed to be “exceptionally alert and
flexible”. His comments, together with those of Don Kohn, his deputy, were
seen as giving the green light for a cut in interest rates from the current
4.5% on December 11, and that the central bank is ready to go further next
year.
When Mervyn King, Bank of England governor, was an academic, he had a room
next door to Bernanke’s. In recent months, however, they have not always
sung from the same hymn sheet. Bernanke is in no doubt that the credit
crisis has affected the US economy: King has been more circumspect about its
impact on Britain.
On Thursday, however, giving evidence to the Commons Treasury committee, King
warned that the Bank was being buffeted from both sides. Food and oil prices
were putting upward pressure on inflation while the “continuing turmoil in
financial markets” was tightening credit conditions, particularly in the
housing and commercial-property markets.
The short-term outlook, King said, was “rather uncomfortable”, and the Bank
faced a difficult task negotiating its way through this “highly uncertain”
environment.
Two pieces of data appeared to confirm King’s message.
Nationwide building society said that house prices fell by 0.8% in November,
the biggest monthly drop for 12 years.
Bank of England figures also showed that the number of new mortgages approved
in October dropped to 88,000, from 100,000 in September. For some, this is
proof that the housing market is cracking under the strain of higher
interest rates and the credit crisis.
The economic gloom goes wider. The International Monetary Fund is poised to
lower its forecast for world economic growth and its chief economist, Simon
Johnson, warned that the world was facing a “perfect storm” of a 1970s-style
oil shock combined with a 21st-century credit crisis. Only weeks ago, the
IMF was confident the global economy would see a fifth successive year of
close to 5% growth, the best since the 1970s.
Other forecasters are already revising down their numbers. Goldman Sachs
sounded the alarm about the US economy last week when it warned that house
prices could fall by 15% from peak to trough, with drops of 30% in some
states.
Some economists now rate the risk of an outright US recession at 60%. Goldman
said the Fed would need to cut interest rates to just 3% during the course
of 2008 to head offa recession.
The big problem, according to Goldman, is that the staggering mortgage-credit
losses will have a “multiplier” effect on the banks’ ability to lend,
slashing the supply of credit to the US economy by $2 trillion.
Jim O’Neill, Goldman’s head of global economic research, said that while the
global economy would be kept going by the “Bric” economies –
Brazil, Russia, India and China – a worldwide slowdown to 4% growth was
inevitable.
America’s housing market has continued to weaken sharply. Prices of new homes
in October were down by a spectacular 13% on a year earlier.
One crumb of comfort was provided by the official measure of US house prices,
produced by the Office of Federal Housing Enterprise Oversight. Although it
showed a drop of 0.4% in the third quarter, the first quarterly fall for 13
years, prices were up by 1.8% on a year earlier. Not since the Great
Depression of the 1930s has this measure shown an annual fall.
The main concern is that the woes in the US housing market will feed back into
further significant losses in financial markets, creating a downward spiral.
The US government is so concerned that it is hatching plans with mortgage
lenders to freeze temporarily interest rates for borrowers with sub-prime
mortgages that are due to move to higher rates in the next two years.
Morgan Stanley estimates the cost of borrowing for British consumers has
jumped by 70 basis points since the summer. This could reduce consumption by
1.4%.
It will also be harder to get loans. Banks, worried about future losses, are
hoarding cash while their appetite for risk has shrunk dramatically.
Central bankers are stepping in. Last week, fears about the ability of banks
to fund themselves over the volatile Christmas and new-year period led the
European Central Bank, the Federal Reserve and the Bank of England to
announce plans to provide extra funds for banks to borrow. NOT everyone is
gloomy. Optimists point to strong company profits in America and Europe. In
the US, shoppers still pack the malls and travellers jam the airports. The
festive shopping season kicked off well with sales on Black Friday, the day
after Thanksgiving, up 8.3% on last year.
“There is a decent chance we will end up skirting by and this period will end
up being recalled as a pause and we will see a cyclical second wind. It
could be that a year from now things are looking much brighter,” said a US
strategist.
Yet such views are in the minority. Some companies are already feeling the
pressure, with a series of UK companies, including the jeweller Signet and
car dealer Pendragon, issuing profit warnings last week.
The mood was best summed up by Hamilton James, chief operating officer of the
private-equity house Blackstone: “The mortgage black hole is worse than
anyone saw. Deeper, darker and scarier.”
“What we are waiting for is greater clarity as to what all these developments
of the last few months mean for the real economy and how markets will
react,” said one strategist.
It will be many, probably nerve-jangling, months before that wish comes true.
PRIME PICKINGS FOR HEDGE FUND
BANKS around the world have seen their profits battered by losses related to
the sub-prime crisis, but for a very select band of hedge funds the credit
crunch has delivered spectacular returns.
Paulson & Co, the New York-based hedge fund run by John Paulson, has made
a killing. Some commentators have speculated that the group may have pulled
off the most profitable hedge-fund trade of all time, making a staggering
$12 billion (£5.8 billion) profit across a series of its funds.
Paulson, a highly secretive group like many hedge-fund operations, raised $2
billion last year for two funds set up to bet on a crash in
sub-prime-mortgage-linked securities by using derivatives. The funds are now
understood to be worth more than $8 billion and were up by more than 550% at
the end of October – even taking into account fees and a 25% cut of the
profits.
In addition, Paulson also made similar bets in three of its so-called merger
and event arbitrage funds, which normally attempt to make huge returns out
of company takeovers or bid battles. These are thought to have doubled
investors’ money.
Paulson’s wildly successful bet is likely to join the ranks of legendary
hedge-fund trades, and could also make him the highest-paid hedge-fund
manager in history. The profits eclipse the $1 billion that George Soros
reportedly made when sterling was forced out of the European exchange-rate
mechanism, or Paul Tudor Jones’s correct prediction of the 1987stock-market
crash, which enabled him to double his money in just one month.
However, in terms of pure returns, Paulson has been topped by a fund set up by
Lahde Capital, a small specialist group founded by Andrew Lahde in Santa
Monica, California, in 2006.
Last month, Lahde Capital’s fund became the first to pass 1,000% returns after
fees in 2007. Nevertheless, Lahde’s storming returns may be ending. It has
started to return money to investors claiming the “risk/return
characteristics” have become less attractive.
Instead, Andrew Lahde has used his tremendous record to raise a new fund,
which is taking big bets on falling commercial property and was up 42% in
its first two months.
Hedge-fund watchers say few funds are likely to have shared in the bonanza
from shorting sub-prime securities. Few specialise in this area, while a
number of more broadly based funds moved away from sub-prime-related bets.
There have also been big losers – the investment bank Bear Stearns closed
two hedge funds after combined losses on sub-prime bets of $1.5 billion.
