It was too good to be true…

After the bail out, new problems emerge – wouldn’t you know it. It was too good to be true. First the Peston version.

“ Treasury may have to abandon its stipulation that no dividends can be paid to shareholders in RBS, HBOS and Lloyds until these banks have repaid preference shares which they are selling to the state… The prohibition on dividend payments has spooked our big investing institutions.
It’s wreaking havoc in particular on Lloyds TSB’s share price, because its takeover of HBOS would give it a vast burden of preference shares to pay off”.

So much “havoc” in fact that “it may be several years before Lloyds TSB, in the process of taking over HBOS, can return to paying dividends, which represent the life-blood of the small investment community.” So, say opponents, “the hastily-arranged merger deal should now be reconsidered.”

Nor will the banks “be able to comply with the government’s preliminary demand to keep lending at 2007 levels ” if borrowers are waiting to see how much further house prices will fall .”
“The government quite clearly hadn’t thought through their comment,”
`Wasn’t that the problem we got ourselves into in the first place. Should people be offered that amount of money again?”

Part- nationalisation is surely not easy option, it’s probably the worst, like Churchill’s view of democracy, apart from all the others. I would guess though that after a lot of shuffling around, the situation will stabilise and the RBS-Hbos merger will stick. Can I ask a naive question: would it be so terrible if the banks, faced with a stagnant housing market, paid off a lot of debt, as Northern Rock are doing, before stimulating that market again – nice and slowly? The Rock amazingly had reduced its debt from £26.9 billion in December to £11.5 billion by the end of last month. But to answer the question, the Rock is now warning that falling house prices reduce the value of its assets and therefore its ability to pay back the debt. It’s a mind-numbing chicken and egg situation for banks loaded with housing debt – and that means Hbos as well as Northern Rock.

Meanwhile we’re told here that “The new scheme will be a big earner for the Treasury: 150 bp on an expected £250 billion take-up equates to £3.75 billion per annum. The Special Liquidity Scheme is likely to generate a further £1.5 billion (based on an assumed average 75 bp fee on take-up of £200 billion), suggesting a total payment from banks to the Treasury / Bank of England of about £5.25 billion per annum.”

If you’re with me so far, here’s another question. I make it that this “big earner” on the £37 billions borrowed will take at least seven years to pay off at that rate. Very fast maybe for huge debts but does that mean part-nationalisation is set to last at least that long?

Banking fiends and opinionated (but non-bluffing) business students, please elucidate.

By the way, I’m now convinced that letting Lehman’s go to the wall was a huge mistake.

  • The Raven

    “Very fast maybe for huge debts but does that mean part-nationalisation is set to last at least that long?”

    Of course. After all, we were promised that Gordie and Ally would do whatever it takes to see us all through…?

    And if it’s a nice a little earner as some may think…perhaps it’s not such a bad thing after all…

  • It was Sammy Mc Nally what done it

    HBOS is a basket case and Lloyds apparently rushed in prematurely and stupidly to get a bargain. Lloyds will presumably have to go with the deal to buy HBOS and shareholders will have to approve or be faced with the threat of full nationalisation. The government will have to look to a return for the tax payer over the longer term and shareholders will have to put up with no dividends or take a hit on the price. An increase in the HBOS share price and the success of their rights issue could however reduce significantly the size of the government stake.

  • Greenflag

    In this economy behind every silver lining there’s a dark cloud .

    ‘By the way, I’m now convinced that letting Lehman’s go to the wall was a huge mistake.’

    Well according to Messrs Dave and others here on slugger the mistake was they were’nt let go to the wall earlier . It seems Paulson is not yet in a mood to admit he did’nt move fast enough but then he’s been farting around for the best part of a year trying to shore up the unshoreable .

    Gordon Brown did the best he could quickly . Paulson was very slow off the mark and when he did produce his three pages he set up a political hornets nest that has cost McCain any chance of winning the presidency . Would be Republican Senators and Congressmen around the USA would like to have the choice of either hanging Paulson or having him garrotted .

    And does’nt Mr Bush look strangely disturbed these days . The man looks as if he has no idea of what’s going on and or why and the silence from his sidekick Cheney is deafening apart from of noise emanating from the shredding of sensitive documents as he tries to cover up the flagrant violations perpetrated by the neo cons on the American Constitution.

    Part nationalisation will be around for the next two Governments at least and probably longer .We are entering a new ‘paradigm ‘ as they say .

  • All the banks destroyed their balance sheets long before 2007, losing money that didn’t really exist and sowing the seeds of the inevitable recession by doing irrevisible real harm to the real economy. The harm has been done but we haven’t noticed yet because we’re only just now entering the hangover. We can’t go back in time to stop the drinking and drug abuse of the night before. And there’s no point debating small issue like Lehman’s or even the price of oil, because the world economy was on its twentieth tequila long before 2007.

    The best we can hope for is to minimize the hangover, for example 10% unemployment instead of 15%. The fundamentals of this recession are sound! And we can’t blame pessimism, or the timing of the nationalization. (If anything, the media are in fact still quite optimistic compared to the reality of the figures).

    As for house prices or mortgages, prices have plumetted and will continue to plummet until they reach fair value which, even if we hadn’t even had the credit crunch yet, will require further falls. The simple fact is that house prices are still too high by any objective standard and that one would have to be very drunk to believe otherwise. There is no shortage of willing buyers, and probably no shortage of suitable mortgages; the only reason there is no transactions is because sellers continue to have ludicrous high asking prices – it isn’t the buyer’s fault that the sellers are in negative equity.

  • The Raven croaked….

    So, Aaron, now that the end of times has come, should I buy my survival gear with a credit card…?

  • Comrade Stalin

    Sammy, my impression is that Lloyd’s were probably bullied into the HBOS deal. The institutional shareholders who own both Lloyd’s and HBOS made it clear that they backed it as well, undoubtedly oiled by the government themselves. I imagine that the deal was only renegotiated when those same institutional shareholders got involved.

    The setup back at Northern Rock to get the money paid back is reasonably straightforward and it looks like it adds up. The Rock’s loan interest rates are being set up so that they are not competitive. If the borrowers decide to stay with the Rock when their deal ends, or if they decide to borrow from it, they’ll pay interest over what they could get elsewhere in the market, going towards the debt. If borrowers decide to leave the Rock and refinance their loans or mortgages with other institutions, hey presto, some more debt just left the Rock’s books. With savings accounts, again the rates are not competitive but there is the bonus of the government backing which makes the money safe; this provides the government with another source of interest revenue. As the debt to the government dwindles, the state may well decide to simplify matters by amalgamating the Rock (and it’s debts) with one of the bigger banks that it has a big stake in. Net result – the government wins. I think things will work differently with the other banks, but the idea is the same.

    I’d bank on this going on for at least 7 years, if not 10 years.

    The only real concern here is that the government could decide it is a little too used to the income stream, and decide to hesitate to privatize it’s share of the banks. And if/when it does privatize the banks, there will need to be a thorough investigation by the Competition Commission, likely taking measures to split up some of the large banking behemoths that will have been formed.

  • It was Sammy Mc Nally what done it

    Aaron M

    “house prices are still too high by any objective standard ”

    There is no objective standard – it depends on the availability of credit and the ability of people to repay ( the real economy and interest rates). As there is now feck all credit then house prices will fall and if their is a recession then they will fall further.

    A couple of months ago when there was plenty of credit the objective standard suggested they were not too high.

    Funny old game.

  • cynic

    Lloyds was a safe well run bank destroyed by others and by the Government’s rush to get it to buy out HBOS to try to save the Government further embarassment.

    Lloyds shareholders now have two choices.

    First they can continue the deal at a much lower cost and, work off the preference shares. The costs seem huge but so is the potential future profit and Lloyd’s will then have a much enhanced UK position. HBOS was always a bit of a shambles and there must be huge savings to be made through rationalisation.

    Second, if it does not look like a good deal, investors might tell Gordon to go away. They could do a Barclays or just demand the Government support but abandon the HBOS deal. The Treasury will huff and puff but cannot afford Lloyds to fail too.

    I agree on the Government’s conditions. As the economics professor said to the select committee today – they are trying to push water uphill. It’s also plain stupid to set targets in this way when that level of borrowing was the very core of the problem. In a contracting economy mortgage debt should fall. Isn’t that basic economics?

  • It was Sammy Mc Nally what done it

    Comrade Stalin,

    “my impression is that Lloyd’s were probably bullied into the HBOS deal.”

    This may well explain it – otherwise HBOS should be in serious trouble for concealing the full extent of their problems which only came to light well after the Lloyds deal.

  • It was Sammy Mc Nally what done it

    cynic,

    “The Treasury will huff and puff but cannot afford Lloyds to fail too. ”

    They only need to hint at Nationalisation and the (remaining) shareholders will jump ship and the government can run it as they see fit.

  • Aaron M

    ‘It was Sammy Mc Nally what done it’,
    The true value of a house, or indeed any asset, is not a function of the amount of available credit, but instead is the sum total of all future income (or utility value), discounted for inflation/interest. There are a number of ifs and buts around this rather simple rule, but none of them apply to property. To cut a long story short, what would you pay today to own any given house from the year 10000 AD until the end of time? I submit that your answer is zero pounds. The value of the years from 2008 to 10000 is just the sum of the rents (discounted for inflation/interest). Hence, property prices are always going to be in and around 20 times rent. This ratio had reached approximately 100 times recently and that is total and utter nonsense, unless of course you believe that rents are going to go up by a factor of five soon. But with the construction sector building quicker than the population was rising and wage inflation staying fairly low, a fivefold increase in rent was never on the cards!

    I say the amount of credit available is irrelevant because we can see that reasonable prices are found by the market for everything from bread to cars and luxury yachts despite the fact they are typically bought without resort to credit. The lack of credit is not relevant now. Prices have to fall to well under 20 times rent before we can start blaming a lack of credit for those unnaturally low prices.

    It’s still much cheaper, and more flexible, to rent than to buy. And you’ll be more likely to be able to afford to buy a house outright in 25 years if you rent now and save up. Renting now is a win win situation until prices fall more. Why rent money now at a higher interest rate, then blow all that money on an overpriced hovel, when you can rent the property instead?

  • It was Sammy Mc Nally what done it

    Aaron M

    “The true value of a house, or indeed any asset”

    is what people are prepared to pay for it.

    That is how the market works – if people like buying houses because it is trendy or any other funny reason then that determines level of house prices – provided there is sufficient credit avialable and they can afford the repayments.

    The price of bottled water has nothing to do with the cost of production but because people are prepared to pay for the bubbles… which rather appropriately is exactly the same with house prices.

  • Aaron M

    That’s why I used the term ‘true value’ instead of ‘price’. The latter is just the amount of money which buyers and sellers can agree on (don’t forget about the price at which sellers are prepared to sell, that’s important too), but I’m trying to give a name to the slippery concept of what the price would be if people really were more rational and had more information. For example, if everybody really knew what all these derivative financial instruments were made of, the bubble would barely have started in the first place.

    I do understand your concern about my terminology. There is obviously some subjectivity about such things, and we let the market try to decide whether assets with fairly fixed incomes (such as property) are really worth 15 times income or 30 times income, but 100 times income is well outside any sane error bars.

    Believe me, I’m not some Marxist trying to apply simple formulas that give perfect prices in some hypothetical equilibrium state. I understand the free market and that fact the everything is constantly changing unpredictably. But some prices are just laughably wrong.

  • lorraine

    can anybody explain in plain english how one day we have an abundance of money, the next day a paucity ? where did it all go ? is some rich, manipulative minority hoarding it under their beds?

  • Aaron M

    I think we’re going around in circles and probably agree with each other more than you think about the vagaries of pricing. I agree with you 100% on the water and it’s nothing new to me.

    My point is that is is very certain that house prices are still ludicrously high, and that the credit crunch and recession are less relevant to the obviousness of this than many would think. Of course you can’t be 100% certain of anything, but you can be more certain of this than you can be certain of the price of anything else. Secondly, this was obviously true even during the boom.

    “I have discovered a truly marvellous proof of this, which this margin is too narrow to contain.” (sorry Fermat)

    Unfortunately, it’s getting late and I can’t go on too much about the details.

    I don’t know if I can sum it up neatly, but it’s clear that most people wouldn’t buy now even if prices simply levelled off for a while. This is because it’s now clear, just as it was for most of the last few years, that nowadays it is cheaper to rent than to buy and that renting is also to best way to be able to afford ownership in the long term. As a result, prices will fall and then level off, only when it starts becoming cheaper to buy than to rent. Just as company shares fall (even in the best of times) when the dividends and projected dividends are too low, then price of houses will continue to fall.

  • Dave

    Every bank has the option of selling assets to raise capital to reduce its debt, so the Rock can dispose of its good assets to reduce its debt but the taxpayer is still left with the undisposable so-called ‘toxic’ assets. Contrary to how the govenment is spinning this, the taxpayer is now exposed to emormous risks by the reckless actions of government. To concentrate minds, just four of the UK’s banks have a combined balance sheet of over 5 trillion sterling, so a fall of a mere 1% in value leaves them with a 50 billion loss. If the value falls by 20% (and we simply don’t know where they stand in the current markets wipe-out), then the UK taxpayer would take a hit of one trillion pounds. Magic pixie dust sprinkled by the halfwits that the public elect won’t turn toxic waste into gold. On the plus side, 5 out of 8 the UK’s banks major banks claim that they can raise capital with recourse to public funds, so it seems that not all banks exposed themselves to risks on the back of the cheap credit bonanza that was creatd by the EU’s ECB and the foolish policy of the Bank of england to keep interest rates as low as the ECB set them in the EU in order to stay competitive with it.

  • Dave

    Typo: …raise capital with[b]out[/b] recourse to public funds…

  • Aaron M

    lorraine,
    It’s called a pyramid scheme. It’s easy for paupers to write each other lots of cheques. As long as nobody cashes the cheques it’s fine and many poor people live happy lives (still in poverty mind you, but happier because they think the future is bright as they cheques keep being written by more and more people). They can even improve their standard of living now by writing cheques to the Chinese in return for goods.

    For ‘cheque’ read ‘corporate bond, off balance sheet vehicle et cetera’. For ‘pauper’ read ‘banks, property speculators, and many millions of others’. And for ‘writing cheques to the Chinese’ look at the trillions of dollars in cash the Chinese have.

    To return to reality, the Western world printed lots of dollars and gave them to the Chinese in return for goods. These dollars are just an IOU. We have yet to earn the real money that will pay off the debt to the Chinese.

    Money is, and always will be, a figment of the imagination. But when the music stops and the pyramid collapses, the contractual obligations owed to the holder of the money (the Chinese) by the printer of the money (the western banking system and the governments which have had to nationalise them) are real enough.

  • lorraine

    It’s easy for paupers to write each other lots of cheques. As long as nobody cashes the cheques it’s fine and many poor people live happy lives (still in poverty mind you, but happier because they think the future is bright as they cheques keep being written by more and more people).

    this is where i fall down. o.k. i’m a pauper and know lots of paupers, now if somebody writes me a cheque at 9.00a.m. by 10.00a.m. it’s cashed!

    don’t blame us for cashing the cheques, it was those other ones with the title which rhymes with banker

  • Greenflag

    ‘where did it all go ?’

    Now you see it now you don’t . The Icelanders are asking the same question .
    It was’nt there in the first place . All of the ‘money ‘ in terms of value was a ‘creation’ of innovative financial designers who lent out the fictitious ‘value ‘ (overpriced housing) to the naive (the buyers 2003 to the meltdown) and then sold the ‘hot air ‘ in neatly packaged tranches to investors and governments and banks around the world .

    As with every Ponzi scheme the few at the top made off with the cash as soon as the bubbles started to burst . The CEO of Lehman’s made off with 460 million dollars etc etc etc .

    The Icelanders will be applying for entry to the EU after this debacle . Fortunately we Irish are within the Euro system otherwise we too could be ‘bankrupt ‘ like the Icelanders who apparently now have to sell their children to the Russians or some such as collateral to be bailed out .Neither the Euro countries nor their ‘Scandinavian ‘ cousins will help them out .

    Nothing like complete national sovereignty eh ?

  • Dave

    Sammy, mark-to-market accounting models are not reliable means of appraising residential property. Unlike other major purchases such as a car, an extension, a holiday in the sun, etc, the property market is subject to speculators appreciating the value with the purpose of reselling the property to release the equity gain. These speculators artificially inflate the value of the property. The value continues to appreciate only for as long as speculators continue to believe that they can sell the property for a profit. Once they believe that the maximum market price is reached, then they withdraw from the market and the property begins to depreciate in value. Because the lender uses the inappropriate mark-to-market method to value the property (irrespective of what models the lender uses to determine the borrower’s ability to repay the loan), the lender is vulnerable to market corrections of property value at the end of this cycle and to the consequent accounting write-downs in the value of his asset. While three-quarters of the lending is to owner-occupiers and a quarter is to buy-to-let investors, there is no category of ‘just-making-a-quick-Euro’ to fit the speculators into. As far as the banks are concerned, this class of buyer doesn’t exist and, ergo, doesn’t artificially inflate the value of the asset.

    Obviously, the value of the property is never written-off (or we’d all be claiming our free properties from the bank’s books), but should revert to the old two-thirds rule that developers’ use to cost projects (i.e. a third of the value is the cost of the build, a third is the cost of the plot, and a third is the developer’s profit). On the other hand, as someone who was lucky enough to purchase property during the bad years, I can recall when property was on sale for less than a third of what it would cost to build it! That, however, was before Ireland became a wealthy country, so you’ll never get bargains like those again.

    There is little doubt that Irish residential property is overvalued and that it will fall probably around 30% or so from its peak. The problem for Irish banks is 30% of hundreds of billions is a whopping great loss! 62% of the total amount that Irish banks lent in 2007 was property-related, so it is safe to assume that those banks will now have assets that are worth substantially less than the amount they loaned for them. On the plus side, those banks loaned money to buy property in the years before and during rapid house price inflation, so it is also safe to assume that they will have assets that are worth substantially more than the amount they loaned for them. If the Irish Regulator says that those banks are solvent, then they probably are.

    Unless we want to repeat this boom-and-bust cycle every 20 years, we will have to require the banks to use a more reliable method of valuing property. Obviously, mark-to-market must be component of it, but it must be qualified by the lender to discount appreciation due to speculation (wherein the value is not based on any function other than profit). I don’t know how that can best be done, but I’d probably figure out after a few hours, so I doubt it is beyond the ability of banks and Regulators to do. At the end of the day, you can’t value property other than via the free market (mark-to-market, i.e. whatever the buyer has paid in precedent), so it’s not a case of restraining property appreciation; it’s merely a case of ensuring that the banks has not exposed to the depreciation. So, if others such as the European Central Bank (ECB) act irresponsibly by proffering cheap credit, then banks will not be exposed to the rapid house price inflation that goes with low interest rates and to the rapid house price deflation that follows it.

  • Harry Flashman

    I thought Lloyd’s was an insurance company, Lloyds was the bank.

  • cynic

    “They only need to hint at Nationalisation and the (remaining) shareholders will jump ship and the government can run it as they see fit.”

    …what and see Gordon (the Great Saviour’s) scheme fall apart so early. Nope. HMG can’t afford that and HMT will do a deal to weaken the terms. Just watch.

    And while everyone is looking at today the market is starting to think about tomorrow. What about the competition issues with so much of UK banking owned by the Government? What will the EU allow? What will be the impact on the wider UK economy? Banks with big debts screw customers to get the money to pay them.

    Already we see that the rules the Treasury are trying to impose re expanding lending are, to put it simply, daft. Let’s see a return to the madness levels of 2007? Why? To shore up the housing market and try to boost the Labour Party’s electoral hopes. Not with my money thanks.

  • Comrade Stalin

    I thought Lloyd’s was an insurance company, Lloyds was the bank.

    Thanks for correction.

    But every pedant takes a fall 🙂 Lloyds is the bank, but Lloyd’s isn’t an insurance company.

  • eranu

    am i right in thinking that if your bank goes down the toilet then you might lose all your savings. but if you have a loan with the bank such as a mortgage, then you will still have to pay this to someone. since its all just numbers on a computer this seems a bit unfair. is that right?

  • lorraine,
    don’t blame us for cashing the cheques

    Aha, but you need to realise that cash is very similar to a cheque! When you withdraw cash from a Northern Irish bank, they just print up a nice piece of paper which says “I promise to pay the bearer on demand”. So the bank can keep printing these as long as it likes, without having to give anything real (such as gold) over the counter to the withdrawer. It really is no better than the bank just giving you a cheque signed by themselves.

    So it’s easy for a lot of idiots to write each other cheques and feel rich. The banks can turn on the printing presses and mints to print the notes and coins in people pockets. But if these starving idiots want to eat, who’s going to supply the food? You can’t eat the notes, so somebody somewhere is going to have to get off their arse and do some real work. On a global scale, we’ve got the Chinese to do the real work over the last few years, giving them cheque which they’ll cash at some future point in order to get us to do real work for them.

    lorraine,
    When you said ‘cashing the cheques’, you should instead have said ‘spend the money on something real like food or a haircut’.