Banks on the brink: Kohler

As previous bank write-downs produce a global economic recession and second leg down of the bear market, banks are being hit by a feedback loop; the economic downturn that was caused by the collapse of the credit bubble and the sub-prime write-downs is it

The $US85 billion rescue of UBS orchestrated by Swiss National Bank is “not a bailout,” said a spokeswoman. “UBS is and was by no means in financial distress.”

Citigroup is “making excellent progress”, said CEO Vikram Pandit last night when announcing a $2.8 billion third quarter loss.

Merrill Lynch CEO John Thain, when announcing a $US5.1 billion third quarter loss last night, said the sale of Merrill to Bank of America would “create an unparalleled global company with pre-eminent scale, earnings power and breadth”.

Meanwhile the hedge fund group Citadel, which used to have $US15 billion in funds and is now down by 26% to 30% this year, told CNBC it is not missing margin calls and is not unwinding any positions.

Spin is a habit, especially when in dangerous times. Spin first, answer questions later, even when you’re in the confessional turning the air red.

As previous bank write-downs produce a global economic recession and second leg down of the bear market, banks are being hit by a feedback loop; the economic downturn that was caused by the collapse of the credit bubble and the sub-prime write-downs is itself causing more write-downs.

NAB chief executive John Stewart reaffirmed to Business Spectator his previous estimate of $1.4 trillion in losses for the global banking system, which means we are less than half way there. When asked whether banks would need to raise more capital, he replied: “Bucketloads.”

In other words the nationalisation of global banking still has a long way to go.

It seems unlikely that too many governments will be prepared to do what the Swiss have done for UBS – that is, allow its worst assets to be shunted off into a “bad bank” fund supported by the central bank. The Swiss Government will end up with convertible notes that could convert to 9.3% of UBS.

Most other governments in Europe are taking a tough line. In Britain for example, there are no cash bonuses for top executives and strict limits on their pay, no dividends for ordinary shareholders until preferred shares have been fully repaid, 12% dividend yield on government investments, banks are required (in return for Government support) to resume lending to homeowners and businesses at 2007 levels, and the Government must be consulted on board appointments.

The US bailouts are much more lax; there are less restrictions on executive pay, dividends can be paid (but not raised), there is no influence over board appointments, no requirement to resume lending, and the dividend to the Government is 5% for five years and 9% thereafter.

We will find out in time whether British tough love is more successful than the American version, and indeed whether the American ideas survive the election of a Democratic president. Clearly the difference between the US and British bailout packages as they stand comes down to the difference between a Labor Government and a Republican Administration.

In Australia the banks don’t need capital yet, just liquidity, and they are getting it from the Reserve Bank and the Office of Financial Management, no strings attached.

But the Australian deposit and wholesale funding guarantee is expected to come with a price attached. The big banks want that price to be risk-weighted; the small institutions don’t, of course, because they would pay more.

In many ways the pricing of this “loan” of the government sovereign AAA rating, especially for wholesale funds, is as important as the announcement of the guarantee itself.

Banking everywhere is going to look very different in 2010. Already it’s clear that to varying degrees the industry will be government-controlled. That means old-fashioned ideas of just lending what you get in deposits will prevail, with wholesale funding as a minor supplement rather than the main game.

But that’s just as things stand now. If John Stewart is right and another $US1 trillion or so in capital will be needed, the future for the banks remains entirely unpredictable, and probably much more government controlled.

A reader, Ross O’Loghlen, sent in this 1802 quote from Thomas Jefferson, one of the American founding fathers: “I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.”

This article first appeared in Business Spectator