Worst crisis for 20 years, say banks
David Smith and John Waples
LEADING bankers are warning of the worst crisis in the money markets for 20 years, which will come to a head this week when $113 billion (£57 billion) of commercial paper – market IOUs – comes up for refinancing.
This huge refinancing, mainly through London, exceeds the $100 billion that became due in mid-August, and which sparked the most serious phase in the money-market crisis, which has seen banks scrambling for funds and market interest rates rising sharply. “This is a serious pressure point,” said one leading banker.
Another senior executive of one of Britain’s top five retail banks said: “These are the worst conditions I have seen in money markets for 20 years”.
The huge amount of commercial paper becoming due is the hangover from the crisis in credit markets that began with American sub-prime mortgages. Many of the off-balance-sheet structured investment vehicles (SIVs) set up by the banks were borrowed in the form of asset-backed commercial paper.
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Now, even if they succeed in rolling over some of this paper this week, they will eventually be forced to take some of it – much of which is of questionable value – onto their balance sheets. To meet this potential liability, banks are hoarding cash and have stopped lending to each other. This has created a liquidity freeze.
“Asset-backed commercial paper is rolling off every day and the banks are taking more and more onto their balance sheets, which is using up capital,” said Paul Mortimer-Lee, global head of market economics at BNP Paribas in London. “It is both a liquidity and a capital crisis.”
His view was supported by a top banker who said: “Even the very solid banks that were not at the sharp end are hoarding liquidity to ensure they can fund the rollover.”
The Bank of England, which last week announced the injection of up to £4.4 billion of extra liquidity into the money markets for each of the next three weeks, is policing the problem, bankers say, but has no plans to change its tactics, which have drawn criticism.
Its first significant response to the crisis came only a few days ago, after weeks in which the European Central Bank and Federal Reserve had injected tens of billions of euros and dollars in an effort to steady the markets. But the Bank’s supporters said the criticism was unjustified, and that it had been right to limit its action. They pointed out that, properly measured, the rise in sterling money-market rates had been similar to that for dollar rates.
The prospect of serious market indigestion from maturing commercial paper is not the only headache for the banks. Globally, they have $380 billion of loans and bonds to be laid off from leveraged buyouts and other private-equity deals at a time when the markets have shifted sharply against them.
The crisis has led to a big change in interest-rate expectations.
After the Bank’s quarterly inflation report a month ago, most economists were looking for a further hike in Bank rate to 6%. Now, according to a survey by Ideaglobal.com, the financial-research company, only 36% think the next rate move will be up, while 64% are looking for the next move to be down.
Most do not expect that to happen until next year, although economists say the situation is changing rapidly.
The Federal Reserve is widely expected to begin the process of reversing the recent rise in global interest rates when its cuts the Fed Funds rate on September 18 in response to the market crisis and weak American jobs data.
Last Wednesday, the Bank and the Financial Services Authority called a meeting with Britain’s top banks to hear how bad the liquidity freeze is.
In the short term, the credit crunch is forcing up the cost of borrowing and the Bank is concerned that this could spill over into the wider economy, making it difficult for businesses to raise long-term finance.
What has compounded the problem is that nobody yet knows who holds the commercial paper that is exposed to the US sub-prime mortgage market and has been dubbed as toxic. Britain’s big banks have varying degrees of exposure but it is not seen as a huge problem. One banker said: “We don’t know yet what we could be holding on our balance sheet in one week or three months’ time. No bank will escape some impact on its profit-and-loss acount. But will it be a mega number resulting in a material hole in its balance sheet? I doubt it.”
Commercial paper is typically soaked up by pension and insurance funds. But until they are able to work out their exposure, many of them are refusing to buy any more. It is this buying strike that has created the liquidity freeze.
Another senior banker said: “What nobody knows is whether this will spill over into the wider economy”.
The crisis is having a huge impact on the way banks conduct their business. Northern Rock, the troubled bank, is facing a battle to raise up to £3 billion in funding it needs from the debt markets in the next three months.
Northern Rock has been particularly vulnerable because it relies on the credit markets for about 70% of the funds it needs to finance its aggressive mortgage lending. Some debt analysts believe that the bank may need to raise up to £8 billion if it is to sustain its ambitious targets and take mortgages that have been written several months ago off its balance sheet.
There have also been suggestions that the funding pressures could force Northern Rock to issue a second profit warning. In June the bank said that £180m to £200m in income had been wiped out after it failed to pass on higher-than-expected borrowing costs to customers rapidly enough.
Other banks, including Anglo Irish, another big user of securitisations, also face a credit squeeze.
The refinancing of the commercial paper is expected to start tomorrow and end on September 20. In that short period the City is braced for huge market volatility.
The big high-street banks are exposed to billions of pounds of commercial paper, a lot of which is high quality. But they will still need the capital to take it back onto their balance sheets. When the markets recover, analysts say there will have to be a post mortem over the different ways that America’s Federal Reserve, the European Central Bank and the Bank of England acted during the crisis. The rating agencies are already being investigated and are expected to be severely criticised.
Have your
say
within this crisis through there is oppotunity for mergers - look at the depressed state of Standard Chartered Bank - where its profits are generated in asia and middle east business is booming and no problems - a timely point for a large instituition with emerging markets ambition to make the bid sooner rather than later
Asian Growth, LONDON, UK
Despite all of this, banks are still offering loans to people ill equiped to make the payments. I have read about a student who was offered a loan, and told that if he did not take it, his credit rating would be viewed as low, and he would struggle to get a loan later on in life. The worst companies are those who always advertise around tea time, offering consolidation loans. If people can't really afford loans, they can't really afford to consolidate them either - these ads play on the lack of financial understanding by people who have no training and little experience, and should be banned.
tony, birmingham, uk
Costas Unfortunatly Cyprus is also not on 'the good diet' - we have a massive property bubble here, fuelled by a massive credit bubble, and an economy that is reliant on consumption and tourism. We are just as vulnerable, if not more, than the UK and USA when this thing spills over into the wider economy. Wake up and smell the keftethes !
Yiannos Ioannou, Limassol, Cyprus
Eric, the UK is much the same as the US when it comes to lending rediculous amounts of money to people who clearly cannot afford to ever pay that money back, subprime mortgages and property flipping. The official figures for our subprime is 8% but I doubt that figure is all that close to the truth, I suspect it will be much higher once its effects kick in with our very shakey economy. The UK is now a nation built on nothing but debt.
Mf Flibble, Cambridge,
It was reported, several months ago, that many that got these subprime loans, were illegal aliens...mostly out West. They should never been allowed to purchase a home, while here illegally or not being a citizen! Reports said many didn't even understand what they were signing.....but oh no...the main stream media and PC folks won't report much on this.
Bobbie, USA, USA
People who complain about the inadequacies of the banking system should perhaps look to the flaws of the alternatives - from the Soviet Union to the UK's own experiences in state planning, other ways of allocating capital are simply much worse. To adopt Churchill's quip about democracy, the global capital markets are the worst way to keep the economy functioning, except for all the other systems that have been tried before.
James, London,
The slow down in home sales in the US is just starting to fall off a very large cliff and by spring we will look back and see the dramatic negative effects to the US and World economy. The slow down in US consumer purchases and lower dollar will slow the US economy and then slowdown the world economy. Witness that the last reported trade deficit for the US was down even though forecasts were it would be up. The slow down has begun already.
Gwilym McGrew, Los Angeles, California / USA
Rank idiocy masquarading as financial sophistication and masked by the most crass and arcane gobbledegook invented to disguise how dumb the financial world has actually become. The bottom line: do you REALLY want your money back when you lend it to someone? Why don't you just give it away and stop pretending you'll get it back!
Chris Thomas, Oxford, England
What happened in the USA - Part 2. The banks really didn't care too much about whether the loans were properly underwritten or not...they simply sold most of the ones they did not want to keep in house. Wall Street ate this up by packaging these into large groups to be sold to investors and hedge funds & insurance companies. The rating agencies did not do a good job of correctly rating these grouped securities as is evidencd by sudden big drops in the ratings starting as early as December 2006. This started freaking out the stock market. The loans they sold these folks started to adjust upwards and they became behind in their payments. European bankers are musch ore conservative and most of these subprime loans would not have been made at all. But the real problem falls squarely at the feet of Greenspan, who after 9/11 flooded the market with low rates and liquidity (good) BUT LEFT IT WAY TO LIQUID TOO LONG. All this cheap capital tempted all the above to people who never should have.
Eric, Washington, USA
Here's what's been happening in the USA the last 4 years: People with poor credit scores (high risk to borrow to and not so good at paying bills, often even coming out of bankruptcy, were loaned money to buy a home. Real estate prices were moving steadily or even rapidly up in some markets. Investors saw rapidly rising markets and bought properties to flip. Both of these groups did not have much in anything to put down, but no problem, the banks and mortgage brokers were glad to sell them loans anyway as they are paid on commission. Many but not all of the lenders lowered their underwritng guidelines so they could compete and get the loan sale. The appraisers saw rapidly rising markets and appraised properties to fit the loans (if they are too conservative then the mortgage brokers do not refer customers to that appraiser and he goes out of business) The underwriters often took these loans without doing a good job of verifying income...just a stated amount will be fine... end Part 1
Eric, Washington, USA
Property is theft. Haha
ZAP, Londonein,
Almost aways, the rich get richer -- no matter up or down. But this time, a rare moment of great satisfaction to the hapless prols, only some of the rich will get richer -- for they all will have to savage each other to see who gets the surprisingly small remainder.
Rick, Orlando, USA
In Cyprus we say "the man who doesn't have the money to buy his bread is lucky because he is on a good diet". This is not the case in the USA and the UK; if you don't have the money to buy something you simply borrowed. Now the time has come to pay and your fat bulk can't move fast enough to adapt to the new conditions. Maybe the man on the "good diet" is more clever than you.
Costas Papadodulos, Nicosia, Republic of Cyprus
Risk is like a wild animal. The fact that you bring it home and cuddle it does not make it tame. This is what banks and investors should have known when they were pricing risk as if it had been outlawed. In fairness to the Bank of England it did warn the banks that they were living dangerously but everybody was enjoying the party too much to listen. There is nothing unusual about what is happening. It's just a simple case of Mr Risk making a collect call on the bankers.
anthony, london, England
As the Chinese appear to wish to diversify their holdings of T bonds and other dollar denominated assets into other assets they are unlikely to be buyers of US government debt. This suggests it will have to be made more attractive to other buyers. So how do you square the circle? Yields on T bonds need to go up to attract the buyers, but US interest rates need to come down to avert a credit crunch. Print dollars instead of issuing debt?
N Reed, Truro, UK
"The Bank Of England's remit is to control inflation. So why are we suddenly keen to feather bed banks who have lent money irresponsibly? Banks have earned fantastic returns in recent years. Let them live with their mistakes. The Bank should concern itself solely with inflation. " Go and watch 'Its a wonderful Life'. If the banks start to fail, as they might, then the financial system goes in to meltdown as in 1929 and the years following. The financial system depends on confidence, as it's all an illusion. I would love to see the scummy bankers and city whiz kids bakrupted and broken. But the scumbags would take us all down with them. "The Bank Of England's remit is to control inflation. " Thought it was look after the financial system as a whole.
Neil Murphy, cromer,
This has all come about because of poorly thought out types of transactions being put together simply to 'justify' paying massive bonuses. Result- nobody has a clue what losses are out there and who has them. Even big banks don't yet understand the possible scale of their own losses, because no-one knows the market value of the 'assets'. What a shambles- all to enrich a bunch of incompetents who clearly don't understand the businesses they run.
Doug, Glasgow,
The sub-prime debt is all secured with real properties with real buildings on them! The shady world of the yen carry market and similar inventions of the "smart money" men to cover their losses in crooked deals in the mid-east and China is a very different matter. These are the same people who bankrupted Barclays. Expect more bank collapses.
Paul Robbins, Alamosa, Colorado, USA
NRK has around £1Bn in cash, if it has to self-fund it's obligations (the £8Bn mentioned), how will it do this, or will it simply default on it obligations (perhaps even go bust)?
Andrew Price, London,
The Bank Of England's remit is to control inflation. So why are we suddenly keen to feather bed banks who have lent money irresponsibly? Banks have earned fantastic returns in recent years. Let them live with their mistakes. The Bank should concern itself solely with inflation.
David B, Larkhall, UK
So we pay bankers £1m+ a year each to lend billions of our money to people who can never possibly re-pay it, who don't bother to take a note of what they lent to whom, then when it all goes wrong and the economy slows, we lose jobs and homes while the bankers laugh all the way to...the bank. Global capitalism is a sick joke, but only the rich are laughing. When are we going to realise it isnt working?
julian, london,
Yippee! Roll the on the mother of all property crashed...
cww, Ipswich,
How do you ensure yourself against this Sue? Buy Gold.
Linus, Leamington,
To quote: "...In the short term, the credit crunch is forcing up the cost of borrowing and the Bank is concerned that this could spill over into the wider economy, making it difficult for businesses to raise long-term finance...." I don't understand this. The Learned Economist at the Times, David Smith and the Council of Mortgage Lenders both assure us that there is no Sub Prime problem and I am sure that they have a logical foundation for this. In the mean time why can businesses and the consumer not keep borrowing against their properties most of which are still 'worth' £200-500k for the moment? Prime Minister Brown Unelect can always put pressure on the BOE to allow the printing of the 'money' For me, I think I will invest in wheelbarrows....
Pete Balchin, Solicitor , Bristol, UK
Is it any wonder that financial ineptitude is apparent in the way a large proportion of the general public run their budgets. Here we have the "clever" money men running for cover in an extremely unstable market riddled with unsupported debt. Those same clever people have just spent ten years encouraging the public by every means possible to rack up as much debt as they, the banks, were prepared to support. Now there is a whole load of chickens coming home to roost I fear for Joe Public who will ultimately pay the price of others incompetence.
mike gee, bournemouth, uk
Typical media scare-mongering. Stock markets will shrug this of imminently, and by next spring will be 20% or more higher than now.
Mike M, Brookline, USA
Are you telling us that banks have loaned more money in total than there exists in total, so the Federal Reserve and the European Central Bank, and maybe the Bank of England, are simply inventing more cash from nowhere? They are just printing money and using it as if it has really been created by wealth makers when it doesn't really have value to back it up? This would mean a massive devaluation of every currency this is geing done to, Euros, and Dollars, and Pounds as well if the BoE is involved. We will be back to bartering for goods and services like they were in Siberia! What value my bank balance then? If this is true they are going to have us all in the same hole as Zimbabwe. What do these central banks do if not make sure the money they are regulating is of real value? Wages would be worthless, jobs not takeable. And to reality - what do I do to ensure myself against this?
Sue Doughty, Reading, UK
Here you! Banker. I have a large brown parcel which contains securitys worth £100million but they will be worth £200million in 6months.i,ll let you have them for £75million.Is the financial system that stupid?
colin, peterborough,
There are strong divergent views on the subject:while the IMF says that the subprime crisis will impact the US and the global economy in general, while the World Bank economist (Francois Bourguignon) said that" the US housing finance crisis will be resolved in a couple of months without much impact on the broader US economy...any effect on the subprime crisis on the expansion of the US economy would off-set by the faster-than expected growth in the first half of 2007... as a matter of fact,we aree not even modifying our forecasts". Bottom line: nobody knows really and that is positive.
Clement, Paris, Franc
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