Bank Lending A Tale of Two Sectors

Bankers are the new Trade Unions! Regular readers will know that this blog has been harshly critical of the way that the credit crisis has been managed, particularly in the UK. This is not a position taken from the 'politics of envy' or an underlying belief in collectivisation.


Bankers are the New Trade Unions

On the contrary, the strongest criticism of the actions of redistribution of income and resources towards the banking sector-this always happens when there is a financial crisis- is that it is in direct opposition with free market principles. Upon reflection, the financial industry leaders should be seen to be more akin to the trade union leaders of the 70's and 80's. Depicting them as a collection of  'Gordon Gekko like' figures is actually damning them with faint praise. Gekko was ruthless, greedy and corrupt but at least he was efficient!

The trade union leader analogy is accurate because of these groups have a handle on the public purse and are seeking to use political muscle to enact a massive redistribution of income towards their special interest group. However, the trade unions never succeeded as well as the bankers did. Scargill thought that coal was 'too big to fail', he was wrong. The bankers had the advantage of being too big to fail, and they have gamed the taxpayer accordingly.


Creative Destruction being Destroyed

Aside from the moral considerations, is the fact that capitalism needs the 'creative destruction'. It needs the failures to be moved on to more productive enterprise. When corporation fail, their managements get moved on and new people are brought in, or the market will not support any restructuring plan. That is the way it works. Why is it any different for the banking industry?

These thoughts came to mind following the release of a couple of news pieces this week.

Firstly,  Lloyds agrees to pay £500m mortgage refunds

Britain’s biggest high-street lender, will pay refunds worth £500m to hundreds of thousands of its mortgage customers in the largest consumer reimbursement agreed with regulators.
About 300,000 customers with mortgages sold under the Halifax brand between 2004 and 2007 are in line for payments ranging from £5 to thousands of pounds after the bank failed to make clear how much interest they were paying on their mortgage.

So, yet more evidence comes to light of the pitiable management by the banking industry.


An Alternative View From the Building Societies

However, an alternative approach could be discerned from some of the traditional building societies. For example, looking at the latest statement from the Leeds Building Society

Chief Executive, Ian Ward, said, "Leeds Building Society has again delivered a very good set of financial results despite the continuing challenges for the financial services sector. Another year of record operating profit, record savings balances and 52,000 new members demonstrates that our successful, sustainable business model continues to deliver security and value. 

"Our new lending increased from £922m to £984m in 2010; this represented £250m above our market share. We continue to adopt a prudent approach to lending as demonstrated by our average loan-to-value (LTV) on new mortgages in 2010 being just 53%. Furthermore, all of the Society's residential lending is funded entirely by retail savings.

"In 2011, we plan to increase our new lending by at least 25% to around £1.25bn. This will be welcomed by home buyers as we provide more capacity and choice to the UK mortgage market.

Now the question has to be asked. Why isn't the Government doing more to promote these sorts of organisations? They should have been rewarded with increased market share following the follies of others. However, the policy of choice has been to carry on bailing out the perpetrators of the credit crisis rather than rewarding -or rather letting the free market reward- those who really did know the meaning of the word 'prudent'

Project Merlin

Project Merlin won't Stop Barclays Rewarding Themselves for not Buying ABN Amro

The UK Government is expected to announce the results of the 'project' to make a deal with the banking sector over bonuses and lending. The public relations people have obviously been busy this morning because the details are being leaked all over the press.

 According to press sources, the deal will involve the banks agreeing to lend $190bn to business, whilst agreeing to pay lower bonuses for 2010 than in 2009. Furthermore, the banks will be forced to disclose the pay of the top 5-10 earning executives as well as the most senior executives on the board.

This comes after the Government had increased the bank levy, raising £800m in tax revenue. Whilst the levy is seen as raising £2.5bn this year, the latest changes are believed to result in a net tax cut to the banks due to the cut in corporation tax from 28% to 24%


Thoughts on Project Merlin

Frankly, I think this is a largely cosmetic move. It does not deal with any of the fundamental issues and represents a 'fob off' to the taxpayer. It deals with none of the problems of the crisis as brilliantly articulated by Mervyn King in this link here

Firstly, the deal over disclosure of the pay of the top earners is largely a move to allow the press to focus on what the top earners are pulling in. Whilst this will help the media sell newspapers, it will not deal with the fundamental incentive issues that caused the financial crises. What marginal difference will it make to the strategy of Barclays if Bob Diamond* is forced (via press pressure) to take a bonus of , say £7m, from the £9m he is believed to be earning this year?

Moreover, what difference will it make to the banks risk management policies will it make, if the top five earners have to disclose their salaries? As for disclosure over the senior executives on the board, I should remind readers that, by UK law, anyone is entitled to walk into a publicly listed company and immediately, be granted details over directors pay.

Secondly, this 'deal' essentially represents confirmation that the banks really are just gaming the taxpayers with the tacit collusion of the politicians. The proper role of the banks is to lend capital on the back of assets and, earn a small cut in the process. That is their job. However, this negotiation sees them horse trading over lending money British business in order to being given an easy ride of bonuses.

Is it worth reminding readers that the point of taxpayers bailing out the banks was to ensure lending in the UK economy? The bankers seem to think it was in order to secure their salaries.

Finally, the banks are expected to pay out £6-7bn this year in bonus. Whilst this is scandalous in itself, it does not include an estimate for the hikes in salary that they awarded themselves last year, in order to get around the bonus tax. Furthermore, it is confirmation that nothing has changed with regard the incentive structure that created the mess in the first place.

What is uniquely insidious in this is that the UK Government probably wants the bankers to get the bonus because they still think that the best way to get tax revenue is to encourage the UK financial services industry to resume their pre-eminent position. Furthermore, as the industry makes up 14% of GDP, these huge bonuses will encourage a few billion into the London housing market.


UK Economy , Housing, and Bankers Bonuses

Now, let's put the facts together. The latest RICS housing market survey indicates that supply of housing for sale is not forthcoming in the UK market. Similarly, demand is low as a consequence of buyers being unable to get funding, because unemployment is high and banks aren't lending. All of which, isn't particularly positive for the UK economy due to the high correlation of the economy with the 'wealth effect' of high house prices.

Solution? Let's continue to redistribute resources towards the banking sector in order to shore up the London housing market and spur consumer spending. In other words, mop up the aftermath of the crisis by germinating the conditions that caused it in the first place.



*It is worth reminding readers of the track record of this man, who delights in telling UK parliamentary committees that it is time for the banks to stop 'apologising' for the crisis. Bob Diamond was  involved in Barclays trying to outbid RBS for ABN Amro and, despite any press spin, there is no public record of him opposing the attempted purchase.

Source:

RICS Housing Market Survey

The Next Bubble is Emerging Markets?

There is a school of thought that sees investment as merely a game of hunting out the next asset class bubble and then following it, before trying to jump off when the inevitable bubble bursts. I think the process of how this works was best articulated by George Soros in 'The Alchemy of Finance'. 

In short, asset prices rise in response to a fundamental based trigger. This causes a lot of attention and then the fact that the price is rising than becomes a driver for more earnings growth. This may appear to be an abstract idea, but I have found it to be realistic. The process works in many ways, one example being the ease with which companies with high share prices can then get funding by selling stock. Anyhow, I digress!

The point is that that this process inevitably collapses when a 'tipping point' is reached which means the price no longer keeps rising and suddenly the drivers collapse. Furthermore, much of this process is about how sentiment favours an asset class.

The dotcom bubble scared investors out of equities. They then moved onto housing, gold, hedge funds, emerging markets and commodities. In other words, anything but Western equities. US housing has now fallen to the periphery of investor interest and hedge funds proved not to be 'hedged' in 2008. I'm not convinced commodities are out of favour and I'm sure the gold bubble will blow up at sometime.

The strongest candidate seems to be emerging markets and no, I don't know when the bust will occur. However, what I do know is that Portuguese 5 year CDS....

....should not be priced more expensively than Egypt 5 year CDS

 In other words, it is cheaper to insure default against Egypt's debt than it is for Portugal's!

UK PMI Numbers and M4 are Indicating Growth

Don't Count Off UK Engineering Just Yet

UK Manufacturing PMI numbers rose to a new high at the start of 2011. According to the report

"UK manufacturing steamed ahead in January as the sector continues to expand quicker than even the most optimistic amongst us could have predicted. As well as improved market conditions abroad, demand in the UK market also showed signs of growth. This is the much needed kick start to 2011 everyone in the sector was hoping for,particularly in the light of last week's poor GDP figures.'

and this demonstrates the resilience of the sector in the face of considerable cost pressures.


It also suggests that the UK is capable of developing a thriving and competitive manufacturing sector in spite of increasing global competition. There was some other good news from the Bank of England.



Bank of England M4 and Lending M4 Figures 


Source: Bank of England



They indicate that some lending is returning to the Household sector and to Private Non Financial Corporations (PNFCs).

Whilst this is nowhere near the levels of the early naughties, I doubt that anyone would want it to be!

What it does indicate is a gradual transition to the much talked about 'new normal' of lending.

Source: Bank of England

The lending effect can be seen when taking a look at the second chart which excludes the effects of securitisation.

Excluding securitisation, M4 growth remains negative. All of which goes to reiterate the importance of getting the capital markets going again in 2009. The recovery would not have been sustainable without it.

Cameron's Economic Priorities

The UK manufacturing sector has demonstrated that it can be competitive and generate growth. The 2001-2003 recession was caused by the aftermath of excess of capital spending which was aided and abetted by a stock market boom. UK corporations learnt the lesson and when the recent recession hit, they were in pretty good shape to handle it. Moreover, they generated good growth in the recovery, despite a major resumption of bank lending. Indeed, Industrials have led the stock market rally.

Unfortunately, by insulating financial corporations from the full effects of creative destruction, the same learning process may not be taking place in the banking sector. I have to gaze on in incredulity as the UK banking sector prepares to award itself £7bn in bonuses, meanwhile its assets are threatened by ongoing doubts about some peripheral European Sovereign Debt.

It gets worse. The last few years have seen a massive shift of resources from the taxpayer (households and PNFCs) towards the financial services industry. I need remind no one that this is a failed industry.

As a consequence, it is fairly easy to see what Cameron and Osbourne should be focused on.

1. Enforce the separation of investment and commercial banks in the UK. Too Big To Fail can never be allowed again. Lending is too important to the economy
2. Allow the market to increase the supply of housing by deregulating. This will spur growth and employment and slowly wean the UK of housing speculation as a career path
3. Support manufacturing and IP based endeavour as a growth opportunity for the UK. Not only by doing the above, but also by encouraging private sector investment

The simple fact is that the default position of UK politicians is to kowtow to the Financial Services industry. In fact this practice has got so insidious that it directly impacts the growth opportunities for the rest of the economy. UK manufacturing doesn't even have to ask for any favours. It just needs a level playing field.

Source:

Sectoral Breakdown of M4 and M4 Lending Bank of England Website (Accessed 1st February 2011)

Markit/CIPS UK Manufacturing PMI  Markit website (accessed 1st February 2011)

The Bank of England released statistics for M4 money supply. These figures are important because historically M4 growth has correlated nicely with future GDP growth. I've added the charts.