Month: July 2012

Why Market Moves Have Been Misguided

As U.S. stocks and the European equity index ended last week in positive territory, against a backdrop of disappointing data, market moves seems misplaced. Instead, Central Bank action is cosmetic not medicinal, a tool for reassurance not economic change. Developments from the recent EU Summit are either temporary or limited and capital remains restricted. However, economic deterioration heats up the pressure for action. Therefore, Central Banks are damned if they act and damned if they don’t. For sentiment to turn, we need to see signs of stability, as well as support.

Watch this being hotly debated on CNBC, with an entertaining edge…

Central Bank Action is Cosmetic Not Medicinal

Central bank action is being met with scepticism, and initial market rallies used as selling opportunities for profit taking. This is because moves are cosmetic and not medicinal, as in the short term they may reassure markets that measures are being taken, but they are of limited effectiveness at significantly boosting growth. Even Draghi himself, the President of the European Central Bank, argued “price signals (have) relatively limited immediate effect”. They won’t stimulate demand and, by potentially hurting bank profitability, could reduce the incentive to lend – the opposite of the target outcome.

Nevertheless, for the first time, we have seen the ECB cut the benchmark interest rate below 1%. In the same week, the Bank of England announced it will be increasing asset purchases by £50m. With weak US data and Bernanke already cautious, the pressure will be on to turn ‘Operation Twist’ into a more traditional waltz. Investors will be hoping the Fed will pump more liquidity into the system instead of ‘twisting’ or neutralising purchases by selling elsewhere along the yield curve.

Summit Moves Are Limited

The outcome of extensive talks at the EU Summit likewise fuelled a ‘false rally’. Spanish government bonds have since returned to hover around the unsustainable 7% level again despite developments. Instead, the 3 key ‘achievements’ are temporary or limited, as explained below…

1.     Senior not guaranteed: Investors have been moved higher up the pecking order and will now be repaid for loans made to Spanish banks before the bailout fund. Being the ‘first’ in line to get money back is indeed an improvement but crucially the risk of loss is still there and may continue to worry the markets.

2.     Wishful thinking? The government has been removed from the equation with bailout funds now able to offer loans to struggling Spanish banks directly. Removing government involvement in bank bailouts to protects sovereign bond yields ignores the possibility investors will continue to view the health of the banks as a driver of economic health.

3.     Bond buying boost limited: Bailout funds may now buy debt directly from “solvent countries” (read: Italy). However, this is a limited source of demand and again short-sighted.

Capital Remains Restricted

The size of the problem remains a key concern and a crucial measure missing from the Summit was a substantial strengthening of the ‘firewalls’. At €500bn, the rescue fund is only 20% of the €2.4tn combined debt burden of Spain and Italy. The risk that a lack of funding will leave European leaders unable to stop the crisis spreading remains.

Economic Deterioration Heats up the Pressure for Action

With a backdrop of a deteriorating economic environment, Europe is far from able to ‘grow out of the problem’. German manufacturing deteriorated for 4th consecutive month. Relied upon as a rare source of growth, the outlook is dimming. European unemployment has reached its highest level since the creation euro. This is unlikely to spur spending and instead put the pressure back on Central Banks to do something to kick-start economic growth.

Therefore, Central Banks are damned if they act and damned if they don’t. For sentiment to turn, we need to see signs of stability, as well as support.

Note some of this article has been published by the Financial Times

Banks: Why We Can’t Use a Sledge Hammer to Correct a House of Cards

Watch this as a 1 minute clip on Newsnight

 

While banks need to earn back our respect, moves to strengthen the system should be handled sensitively.

The challenge is that a low level of regulation hasn’t worked while too heavy handed regulation could be just as damaging. Elevated regulation costs could be passed on to the consumer in terms of higher borrow costs and lower credit availability. The ‘man on the street’ may be the ultimate victim as a tougher environment leads to job losses as companies struggle to finance themselves.

The misunderstanding is that it is not as binary as ‘retail good’, ‘investment banking bad’. Ringfencing and protecting one part of the industry from its perceived higher risk other half is a flawed strategy. Good assets can go bad, as we’ve seen in Europe as certain government bonds have become less and less credit worthy, with the likelihood of default increasing. Retail banks have gone bankrupt, far from worthy of their halos. Furthermore there’s the issue of funding. Retail banks are subsidised by investment bank revenues. Therefore again, those with a high street bank account could be hit with fees to have a deposit account. Although it may be argued this cost is preferable to the possibility of greater losses from instability. Nevertheless, instead of a focus only on separation, the issues to tackle run deeper.

It’s about mitigating the risk not just moving it about. We need interests to be brought back inline & not incentivise  excessive risk taking. Nonetheless, while banks remain fragile, complex & different to each other, the situation needs to be handled carefully.

Quantum physics achieves what Europe cannot – a move towards greater unity

As scientists around the world celebrate the possible discovery of a new particle, European leaders may look upon this with envy. Potentially a great leap forward in unifying the complex and differing elements that make up our world, Europe meanwhile continues to struggle with internal conflicts. From particle colliders to monetary unions, experiments can offer valuable insights into how the world works; neither has reached its ultimate conclusion so let’s just hope envy can be turned into action…

Quest For Unity

In an attempt to elegantly unite all particles and forces in the universe into a single set of equations, the Standard Model strives to be a ‘theory of everything’. However, scientists remained unable to explain how matter attains mass. The Higgs Boson was postulated as a potential solution to this problem, giving subatomic particles mass as they travelled through the ‘Higgs field’. For almost 50 years, this particle was sought and announcements made this week appear to imply something fitting the description has been found.

Progress towards greater unity within Europe is likewise sought. Forming a monetary union to ease trade within the region was the experiment; forming full fiscal unity would be the solution. With some countries in deficit, whilst others enjoy a budget surplus, the imbalances are unsustainable. In order to share debt burdens, budgets must be shared first…

Investment Into A Solution

Substantial investments have been made in both these scientific and economic experiments. The Large Hadron Collider took 25 years to plan and $6 billion to build. It smashes protons at nearly the speed of light, with the debris scoured for signs of hidden new particles. Identifying a particle with a mass that would fit the profile of a Higgs Boson is the reason for the current excitement.

Unfortunately, the €1 trillion of loans offered to European banks cannot be said to claim such a conclusive victory. The loans have failed to be passed on to the wider economy, and government bond yields have crept back up to previous levels.

We’re Not There Yet

Nevertheless, both the scientific world and the political one have a way to go. We are still unable to answer why the 4 forces differ so greatly in their power. And similarly our options to deal with the vastly differing economic power of European countries appear limited. Potential steps forward exist for both. While one needs the building of an even larger collider, unlikely in many people’s lifetimes, the other could be achieved with political will sooner. There is hope for Europe, let’s hope voyages of discovery can inspire action.

Crisis – Coming To A Bank Near You…

Diamonds Aren’t Forever and The Damage Could be Drastic

It appears that ‘diamonds aren’t forever’ as Bob Diamond steps down from his role as the CEO of Barclays Bank, amid investigations into interest rate manipulation. Instead, disruptions to the banking industry will be widespread and with far reaching consequences. Damage to confidence could reign in credit availability even further, lead to job losses and even affect our standing within Europe.

Listen to this as a 5 min podcast on TalkSport

Could I Have Been Affected?

With between 200 and 250 thousand mortgages linked to the benchmark interest rate (Libor), many may have been affected by rate manipulations. However, it is unclear whether they would have lost out or benefited from the activity. Barclays traders have been accused of both pushing up the rate, as well as pushing it down. Depending on the environment, on some days it would have been better to borrow at cheaper rates, and on others to earn more when lending.

Who’s Next?

Barclays is not alone. The investigation into interest rate manipulation has already touched 18financial institutions, with 12 having fired or suspended employees. Furthermore, in addition to scrutiny from the regulators, many banks face private lawsuits as well. RBS is a prime example. After having terminated or suspended at least 4 employees, the bank is facing a wrongful dismissal lawsuit from one of them claiming they were used as a ‘scapegoat’.

Lending & Employment the True Victims

The banking industry is the largest private sector employer, providing over 1 million people with jobs. Already struggling with low trading volumes, low merger & acquisition activity, weak economic growth and tighter regulation costs, Credit Suisse is rumoured to be planning to cut a third of their senior roles in Europe. As Barclays agrees to pay a $451m settlement as a result of these investigations, we see a glimpse of the additional burden banks will have to bear and the further cost and job cutting that may result.

In this environment, banks will not be encouraged to lend. Lending: More than £100bn of lending has already been withdrawn from the economy in the last 4 years, regardless of the Bank of England pumping over £300bn into the economy. Small firms are being asked to pay higher rates to borrow and keeping in mind they create the majority of new jobs, again the outlook for employment is worrying. As Chancellor Osborne asserted “What we don’t need is (the banking industry’s) reputation tarnished” instead “we need Barclays to be focused on lending”.

Support for a Banking Union?

As an example of insufficient oversight, these investigations could heat up the debate between those wishing to maintain a level of independence and authority over our banks against those in favour of our participation a Banking Union. This would involve a single regulator to oversee banks across Europe and answer calls for greater control over the banks. However, with the situation in Europe deteriorating, as unemployment continues to rise and debt burdens remain a challenge, there has been opposition towards greater integration.

The spotlight is well and truly back on the banks. Investigations must be handled carefully otherwise it could be the ‘man on the street’ that will feel the consequences.