On the day when the Government anounced its latest bank resuce plan, I thought these comments from Simon Wolfson, the chief executive of Next, in The Times were very apposite. It is rare but encouraging to hear comments from a senior figure in industry that are both thoughtful and sensible, rather than the usual special pleading dressed up as a contribution to public debate. Mr Wolfson makes a number of points to support his argument that the Government should beware of over-reacting to the current crisis.
These three comments seem to me to be particularly apt:
1. “Britain can no longer afford the public sector final-salary pension. Politicians of all parties know that this is a problem that must be addressed. But the longer they delay, the more it will undermine our whole economy in years to come. A good start would be to put all new recruits on a contributory pension while protecting the rights of those already in the public sector scheme”.
2. “Only if credit is still frozen after the Government has reduced the cost of capital and eased the regulatory environment should it look to more radical solutions such as guaranteeing new loans to business or underwriting toxic loans through potentially expensive insurance schemes. If the insurance is too expensive it will represent too big a cost to the banks; too low and it will be too high a cost to the taxpayer. Rash actions will increase the risk that a crisis in private finance will be turned into a crisis in public finance”.
3. “If there is one quality we need, above all, to guide Government in the dangerous months ahead, it is common sense. The length of the recession depends on the avoidance of political grandstanding and our ability to make sensible decisions for the country’s immediate and long-term future. In the past, common sense has deserted our political masters in good times, but reasserted itself in times of crisis. Let’s hope that’s the case in 2009”.
As for the bank rescue plan itself, the market reaction speaks volume. Shares in Royal Bank of Scotland were hammered, falling by more than two thirds. The company is now valued just 6% of its value in 2006. RBS announced a loss of £28 billion, the biggest in UK corporate history. As taxpayers we have opted to swap our 12% preference shares for more ordinary shares at a price that makes the investment virtually worthless. The more we own, in other words, the less the bank is deemed to be worth.
It is hard to disagree with the views of Frank Portnoy, an American professor whose book about corporate greed anticipated many aspects of the current crisis. He argues in today’s Financial Times that the worst affected banks, including Citibank, are for all intents and purposes dead. Govenrments can no longer save them. All they can do is keep them alive by artificial means.
“The bottom line is that, given declining assets and increasing liabilities, many – perhaps most – big banks are essentially insolvent and have been for a long time. It is incredible that they lost so much money on derivatives but even more amazing that they stayed alive for so long afterwards”.
“The banks’ fate was sealed in early 2007, when the value of derivatives linked to subprime mortgages collapsed. A year ago, the crucial triple B rated mortgage instruments that were the surgical focus of the banks’ bad bets had already declined by three-quarters. At that time, some hedge fund managers concluded that the banks were insolvent and took short positions. The smart money said the banks already were dead, or at least close”.
“Although sophisticated investors recognised early on that this crisis was about solvency, not liquidity, and that the liquidity crunch arose from fear that banks could not repay their obligations, others came to this view more slowly. The last, as usual, were the credit rating agencies. On Friday, they finally rose to the pulpit to give Citigroup and Bank of America an overdue eulogy, cutting their ratings. Just as their last-minute downgrades of Enron nailed its coffin, these also might be the end, at least for Citigroup”.
For investors, it remains the case that no enduring recovery in either the equity or corporate credit markets is likely until shares in the banking sector finally end their dismal performance. Even if the banking mortuary is filling up, the sick and the maim still need to come out of the recovery ward. Judging by the events of the last few days on both sides of the Atlantic, that has not yet happened. That will act as a dampener for now on hopes of a sustained market bounce.
Jonathan Davis 