Another Package or Two?
By Adrian Ash
February 14, 2008
Subprime losses already outweigh the Great
Depression, but government bail-outs have barely got started...
BACK IN 1984, the Bank of England in London saved Johnson
Matthey Bank a busted subsidiary of the centuries-old gold dealer with
an emergency buy-out costing just £1.
The debts covered by the Bank of England, however, totaled $309
million by one estimate. (The true total remains secret). They took 10 years to
clear from the Bank's books.
The Swedish government then stepped into the Scandinavian banking
crisis of 1992, buying the 13% of Nordbanken shares that it didn't already own
and paying a 10% premium to the stock price. That defended investors as well as
depositors, in other words.
Washington even managed to contain the US savings & loan crisis
of the late 1980s, protecting savers but letting more than 1,000 finance
companies go under. The direct cost to the US taxpayer was $124.6 billion,
according to the General Accounting Office's report right about the total
bank losses in the subprime collapse so far according to the International
Herald Tribune's last count.
All told, the S&L crisis cost "more than the cumulative
loss of all US banks during the Great Depression, even after adjusting for
inflation," as Jean-Charles Rochet, then a visiting professor at the London
School of Economics, put it in a speech on banking crises of 2002.
Whereas, by its end, the current banking crisis will see total
mortgage-credit losses of $400 billion according to Goldman Sachs' latest
estimate. So "let's be clear and honest," just like Housing &
Urban Development secretary Alphonso Jackson said when launching Project
Lifeline this week.
"One action alone will not solve every problem in the housing
market," Jackson declared as he gave US home-buyers an extra 30 days to try
and stall foreclosure. He could just as easily have been talking about the
entire banking industry.
One action alone won't solve it not even if that one action
does come from Warren Buffett. Or the White House. Or the Federal Reserve.
But altogether?
And what if we throw in an extra $3.3 trillion of foreign
government finance, pouring out of the oil- and export-rich wealth funds of
Arabia and Asia into broken Anglo-American banks? Might that be enough to wipe
the world's greatest-ever credit bubble from history?
"So far, institutions have raised nearly $75bn of capital from
sovereign wealth funds and public sources," notes Joseph Mason, associate
professor of finance at Drexel University and a senior fellow at the Wharton
School, in the latest market note from his private consultancy, Criterion
Economics.
"[But] while the seemingly unconstrained supply of capital
has, thus far, been a blessing, it is not clear that the flow can continue.
Recent events suggest that private capital sources may be reaching their limits,
at least with respect to riskier institutions."
Citigroup just managed to raise funds at 5% interest. It is the
world's largest bank, after all. But MBIA, the biggest "monoline" bond
insurer, was forced to pay 14% on its AA-rated debt as Mason gasps.
"Ambac canceled their most recent recapitalization
attempt," he adds, "ostensibly because the cost was even higher."
So step forward Warren Buffett! The stock market initially rallied
and rallied hard on the idea that the Sage of Omaha might buy up bonds
currently insured by bond-insurance giants MBIA, Ambac and FGIC. Yet as Buffett
told CNBC, he only wants the municipal bonds these firms insure, and nothing
else.
Because get this municipal bonds are currently cheaper to
buy if they come with insurance than without!
A "classic kind of mispricing" for the Sage of Omaha to
exploit, as John Authers notes in the Financial Times, this arbitrage
also shows just how horrified the entire investment world has become by the
"monoline" insurers, thanks to the very same junk that Warren Buffett
will not step in and save.
Clearly, Buffett's offer makes great news for US towns and states
wanting to raise fresh capital to fund their core services. With his prime-beek
cherry Coke check-book at the ready, there's no need to repeat Sept. 1933
when 28 American cities went into default nor the Orange County default of
1995.
Especially not if the Federal government were to stand behind
Buffett standing behind the municipals. Right?
Buffett himself, however, was quick to point out that his offer
"doesn't do anything" for the subprime bonds, collateralized debt
obligations (CDOs) and leveraged debt pushing down on the bond insurer's credit
ratings.
Indeed, "I'm not sure anything is going to do much for the
CDOs," he said. That doesn't mean state agencies and central banks won't
try, however. "Direct government bailouts are gaining in popularity,"
as Prof. Mason notes for Criterion.
He's not kidding!
Here in London, the British government has told the two remaining
bidders for Northern Rock the top-five mortgage lender, hit by a banking run
in Sept. '07 and now supported by £26 billion ($46bn) of tax-funded loans
that it's on the verge of full-scale nationalization.
Northern Rock was moved onto the British state's official balance
sheet last week.
Germany's IKB, currently 38% owned by the state, may see the
government-run KfW development bank raise its stake to 50% effectively
nationalizing the subprime-hit lender because private-sector investors are
unwilling to back a new capital raising.
In France, the state-controlled postal bank La Poste is rumored to
be joining the government-owned Caisse des Dιpots in developing a bail-out
package for Sociιtι Gιnιrale. The country's second-largest bank, SocGen
managed to lose $3 billion on subprime investments a little-known fact given
the $7 billion it lost to "rogue trader" Jerome Kerviel.
This week SocGen raised capital by offering new shares at a 39%
discount to its stock market price itself already offering a near 42%
discount from this time last year.
And in Switzerland, UBS due to report its first loss in history
on Thursday, worth some 4.4 billion Swiss Francs for 2007 as a whole ($4bn)
may gain financial support from the Swiss government if shareholders reject the
capital restructuring proposed by the Singapore government. Along with an
un-named Saudi investor, Singapore's Government Investment Council (GIC) has
offered to put up 13 billion Swiss Francs ($11.3bn) without demanding a seat on
the board.
But the GIC would take a controlling stake, however, since "on
average, 30% of shareholders turn up to vote at the AGMs," as one UBS
shareholder told FinanceAsia this week.
"Somebody controlling one-third of that" and the GIC-Saudi
investors would hold 10% of the total between them "effectively
controls the company."
Does it matter? Maybe. "The investment arms of foreign
governments appear to have saved the day for American financial
institutions," says Steven M.Davidoff for Deal Book. They've also piled
into the biggest banks in Europe too, saving Western governments some $75
billion so far.
On one day alone last month, some $19 billion was raised by
Citigroup and Merrill Lynch tapping the convertible bond markets and Citi's
funding "included investments from sovereign wealth funds in Singapore and
Kuwait, alongside Prince Alwaleed bin Talal, the banks second largest
shareholder," reports Financial News US.
Whatever the Asians and Arabs can do, Washington can do better of
course, starting with the little guy right at the bottom of the subprime pyramid
the over-indebted home buyer himself.
George Bush might have watched 226 mortgage lenders go kaput since
late 2006 (the latest count from ML-Implode.com), but he just signed that $168
billion tax-rebate bill, hoping to stop the current slump in US house prices
becoming a genuine depression.
Not enough, grumbles Senate majority leader Harry Reid. The package
is "far from a panacea," he says, getting ready for a Democrat White
House no doubt.
"Much more should be done. Another stimulus package or
two."
Or three. Or four. You just keep writing the checks, Senator
and get the Federal Reserve to keep US interest rates way below inflation.
We'll just keep Buying
Gold outright with no default risk and store it in privately-owned,
ultra-secure gold vaults, far outside the world's banking system.