John Hole, a Hereford-based trader selling ceramic wall and floor tiles, has
just received a letter from his bank telling him that the interest charge on
his overdraft of £20,000 will go up three percentage points this month.
“It means I’ll be paying 12% instead of 9%. It’s a staggering figure and I
don’t think it’s justified. There was no explanation, it was just take it or
leave it. I asked my local branch manager if there was any leeway and he
said absolutely not.”
In Aberdeen, Mark Esslemont, a partner at a clothes shop, is faced with the
same problem. He said: “Our overdraft came up for renewal in September and I
got a letter telling us with less than a month’s notice the overdraft fee
had jumped from 2% over base to 4.5%. It also slapped us with a £250 charge
for the privilege of filling in the paperwork.”
Hole and Esslemont are the hidden victims of the crisis in the world’s money
markets that has brought the financial system to a halt. And in the months
ahead there will be thousands more like them.
The crisis that has seen banks around the world nationalised or go bust is
spilling over into the real economy and its impact is going to be huge. It
is resulting in a chain of blame. Businessmen are blaming their banks for
abusing their position; the banks are blaming the authorities for not doing
enough to make money more freely available. And the authorities are blaming
the excesses of past lending from the banks for causing the biggest market
meltdown since the 1930s.
The problem is global. The free flow of capital that underpins the economy has
been brought to a shuddering stop. America’s Emergency Economic
Stabilization Act of 2008 that was finally approved last Friday was designed
to address the issue. It gave the go-ahead for a $700 billion (£396 billion)
plan to create a dumping ground for banks to hive off toxic assets.
It was accompanied by fresh initiatives from the Bank of England and the
European Central Bank to pump more liquidity into the system, but analysts
say still more needs to be done.
To understand the crisis, you have to delve deep into the opaque world of
financial markets. Britain’s banks lend a lot more money than they hold in
deposits. They rely on a steady supply of about £500 billion of loans from
the money markets to run their daily business.
It was when these markets started to dry up in August last year that the
credit crisis began, bringing down mortgage bank Northern Rock. The markets
never recovered. Over the past three weeks, as the banking sector collapsed
into the hands of governments around the world, the wholesale money markets
have frozen over.
It is worth looking in closer detail at the aftershocks that followed the
collapse of Lehman Brothers, which brought the inner workings of the global
financial system to a painful, grinding halt.
Lehman Brothers stopped dead on Monday, September 15. In doing so, it left
counterparties across the globe with big holes in their balance sheets. In
Lehman’s London operations alone, there were $13.9 billion of trades that
were suspended mid-trade. Dozens of hedge funds and traders are now
wrangling with the firm’s administrators to get their money back.
Many are now going bust or being forced out of business. Among them is Reserve
Primary, America’s oldest money market fund. Reserve was owed $785m by
Lehman in commercial paper — short-term loans used by banks and large
corporates to finance their day-to-day business. When news of the Lehman
exposure emerged, the fund’s investors were terrified. This was a fund that
was supposed to be among the most conservative on earth, and now it was
facing serious losses. For the money markets, the world had just ended.
“When Reserve Primary fell over, confidence drained from every money market
around the world,” said one London-based inter-bank lending market trader.
“These funds had trillions of dollars raised from US institutions and
individual investors that they could lend to banks for typically up to 13
months. Suddenly it was gone.”
Until recently, money market funds provided about $3.4 trillion of capital to
the global banking sector, which was used to oil the wheels of the system
every day.
In the two days after Lehman’s collapse, Reserve investors withdrew $40
billion from the fund, forcing it to wind itself up. The fear spread to
every other money market fund on the planet — within five days of Lehman’s
demise some $200 billion had been pulled from these funds.
With banks going bust left, right and centre, the little money these funds had
left was being kept well clear of the banking sector. It was mostly being
ploughed into US Treasuries and other government bonds still considered to
be safe. Although Washington stepped in last week, pledging to insure money
market funds, it has done nothing to change sentiment.
As the money markets came unstuck, the collapse of Lehman, followed by the
nationalisation of AIG, the shock takeover of Merrill Lynch by Bank of
America and the takeover of HBOS by Lloyds TSB spread fear across the
markets. It seemed it was no longer safe to lend money to anyone.
Both corporates and the rich central banks followed the money market funds
into buying US Treasuries, pushing the yield down close to zero.
Last week, as Bradford & Bingley, Fortis, Dexia, Glitnir, Wachovia and Hypo
Real Bank all came unstuck, confidence had disappeared. As a result, almost
all the cash left in the banking system was holed up in overnight accounts,
forcing further Bank of England interventions.
“Money markets don’t really care about the long term,” said Laurence Mutkin at
Morgan Stanley. “They don’t take a view on a company’s strategy or whether a
business is headed in the right direction. All that the money market wants
to know is whether the borrower will be able to repay in a month, or three
months, or whatever the timeframe is. If they can, great; if they can’t,
then it’s potentially disastrous.
“In that sense, the money markets are pretty binary. The risk/reward ratio is
out of kilter — if you pay me back, I get a little bit of profit; if you
don’t pay me back, I could get a very large loss. So if there’s any
realistic doubt, I simply won’t lend to you.”
This binary nature of the money markets offers a glimmer of hope. While the
switch can be turned off at a moment’s notice, when it is switched back on
the system can spark back to life relatively quickly. “It’s a credible
scenario — albeit one which hinges on a lot of things coming right,” added
Mutkin.
ALL the evidence suggests that we are still a long way from that point.
Funding lines that British banks normally rely on are simply disappearing.
To keep themselves solvent they are having to make their balance sheets much
smaller, by calling back loans from customers and welching on previously
agreed deals.
The only other option for UK banks is to borrow money from the Bank of England
— funding that has not always been as readily available as the banks would
have liked. The big freeze is gradually icing over the whole economy.
“One of the biggest concerns is that this is beginning to affect companies
that otherwise are very creditworthy,” said Neill Thomas at KPMG. “Many will
need to extend their facilities and will find that some banks are simply not
willing to lend. Banks are not always rational in these circumstances and
good corporates are already finding some banks don’t want to lend.
Conversations could be very difficult for everyone irrespective of credit
quality. This could become a more systemic problem.”
Britain’s senior bankers believe this point is lost on Mervyn King, the
governor of the Bank of England. On Friday King attempted to address some of
this criticism when he agreed to make a further £40 billion available to
banks and widen the collateral needed to tap the facility. This move came
after a meeting on Tuesday evening with the heads of our biggest retail
banks.
One by one, a group of Britain’s most powerful retail bankers filed into
Alistair Darling’s office at 11 Downing Street. They were greeted by the
chancellor, King and Lord Turner, chairman of the Financial Services
Authority (FSA). The bankers included Andy Hornby, chief executive of HBOS;
Eric Daniels, chief executive of Lloyds TSB; Sir Fred Goodwin of Royal Bank
of Scotland and John Varley of Barclays.
The atmosphere was cordial, but there was an air of frustration. For several
weeks in private conversations the bankers had shared their disquiet at the
way King had been handling the financial crisis.
They felt he had been reactive and his actions piecemeal, that he had failed
to recognise the crisis that was building up in wholesale-banking markets
that had made it increasingly difficult to raise liquidity.
The bankers wanted to know if King had a masterplan, and as the minutes ticked
by it became clear he didn’t. “He’s a boffin with little feel for the damage
being inflicted on the economy,” said one individual who was present at the
meeting.
The Irish government had controversially guaranteed more than ¤450 billion
(£350 billion) worth of liabilities in the Irish banking sytem for two
years. American legislators were bad-temperedly moving towards endorsement
of the Bush administration’s $700 billion rescue plan, after causing a
stock-market crash by rejecting it on Monday. What dramatic moves were the
British authorities preparing to make? Well, nothing much.
There was a sense among the bankers that King had ducked making the big call.
His preference was to sit it out quietly and try to fix it the old-fashioned
way, tackling each aspect of the crisis piecemeal.
This week, when the City takes in the details of the American rescue, pressure
will mount on the British government to act, but it will need the support of
King and that may not be forthcoming.
Publicly the Treasury, the Bank of England and the FSA have maintained a
united front as they grapple with the credit-market meltdown. Privately,
insiders speak of angry phone calls and stormy meetings, as each corner of
the regulatory triangle blames the other two for failing to pull their
weight.
In particular, there has been concern among senior figures in the Treasury and
the FSA about the role of King.
One senior source said that last month Gordon Brown was forced to telephone
King and beg him to extend the special loans that were keeping the banking
sector solvent. “There is a sense that Mervyn was not aware how fast this
crisis was moving. He was looking at the issue from a long-term perspective.
But, as Keynes said, in the long term we are all dead,” said a government
insider.
While the FSA has responsibility for day-to-day oversight of the banks, King
retains considerable power to determine whether a financial institution
lives or dies. The Bank of England’s decision to stop lending money under
the special liquidity scheme was the proximate cause of the demise of
Bradford & Bingley last weekend. However, in this case nobody in Whitehall
is saying King made the wrong call.
“In a sense it was King who killed B&B,” said one official. “However, the bank
had no more collateral to borrow against. If it had survived the weekend, it
probably would have been blown away by Monday’s Wall Street crash.”
Another insider regarded the tensions as more constructive. “Mervyn has often
found himself in the position of saying no to government schemes, but it is
his constitutional role to act as a brake on the wilder instincts of
ministers.”
For King’s part, he does not want to squander taxpayers’ money to solve the
follies of banks. The danger is that without action he could threaten
economic stability.
“It is a bit like refusing to let the fire brigade put out a house fire,
because the fire was caused by someone dropping a lit cigarette,” said one
analyst. “Yes, it was their own fault that their house caught fire, but you
can’t just stand their shouting about moral hazard while the rest of London
burns to the ground.
THIS week banks and businesses will be trying to gauge the effect that the
political events of the past few days will have on the handling of the
financial crisis.
In the most dramatic of his many relaunches, the prime minister not only
brought Peter Mandelson back from Brussels to be business secretary but also
set up an economic emergency committee of key ministers, chaired by himself.
Mandelson’s return puts a powerful pro-enterprise figure into the business
slot. It also brings his European expertise — he has been trade commissioner
for the past four years — into the government at the moment when the
difficult European dimension of the financial crisis is becoming most
pressing.
Although Europe has a central bank and cross-border banking, its banking laws
are held tightly by individual nation states. The big concern among bankers
is that while governments and regulators are now acutely aware of the need
to inject more liquidity, Europe will be unable to agree on a co-ordinated
response.
All week — particularly after Ireland’s panic move to protect bank deposits,
which technically breached competition law — bankers and politicians within
the EU have been calling for what Jean-Claude Juncker, the prime minister of
Luxembourg, called a “systematised European response” to the crisis.
President Nicolas Sarkozy of France held a summit to discuss this yesterday
in Paris attended by Brown, Angela Merkel of Germany, Silvio Berlusconi of
Italy, Jean-Claude Trichet, the president of the European Central Bank, and
José Manuel Barroso, president of the European Commission. There were fears
that it would be high on rhetoric and low on solutions.
Speaking at 10 Downing Street before his departure for Paris, Brown said: “We
are seeing, in addition to the national action we are taking, that these
global problems about oil, about the credit crunch, need global solutions.
“So I will be proposing to the leaders I meet in Paris . . . that we work
together to clean up the system, both in America and Europe where there have
been problems, that we call a timetable for international meetings to agree
the changes that will open up those areas which have been far too often
closed and not transparent.”
More pragmatically, however, he also announced that he would be seeking help
for the hidden victims of the banking freeze.
“I will also be proposing a £12 billion small business fund, so that small
businesses in our country and the rest of Europe can get money immediately
so that they can continue to employ staff and continue to provide services.
“In the next few weeks we have got to show how we can do more in Britain and
across Europe to help small businesses, as well as households, through what
is a difficult economic time but where I believe Britain can lead the way
out of the difficulties.”
This may come too late for Hole and Esslemont. “Will a scheme like this help
us? It might make a difference but I’ll take it with a pinch of salt. You
hear so much flannel from the politicians,” said Esslemont.
“Personally, I think he’s left it too late,” said Hole. “After years of
encouraging us to spend, spend, spend and an FSA with no teeth that failed
to keep on top of things, whatever he does now is going to be too late for
some businesses.”
