Just as deleveraging was the watchword for the first stage of the banking crisis, we are now seeing the roots of the second stage: Liquidation.
While “deleveraging” is too ugly a word, unable to compete with the suave “austerity” to be the word of last year, this year the word will be liquidation, writes Left Foot Forward’s Cormac Hollingsworth
As we’ve been arguing on Left Foot Forward, most recently in Ann Pettifor’s piece, since August we have been back in a new financial crisis. Liquidation is the next phase of this crisis, and that next phase is about to begin.
Liquidation was treasury secretary Andrew Mellon’s infamous advice to President Hoover:
“Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate, [because] it will purge the rottenness out of the system. High costs of living and high living will come down.
“People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”
Over the past six months banks have been deleveraging, selling off loans and assets to raise money and reducing their leverage. UK banks have large amounts of wholesale loans to repay in the next two years.
RBS has £36 billion due in 2012, Barclays has £17 billion and Lloyds has £26 billion, a total of £79 billion. That is £4 billion more than the Bank of England’s £75 billion of quantitative easing, so don’t hold your breath about that expanding credit.
But then in 2013 RBS must repay £16 billion, Barclays £8 billion, and Lloyds £12 billion. By then the government’s guarantee scheme will be up and running, for only £20 billion versus £36 billion of repayments.
Unfortunately guarantees are no good if banks can’t raise the money in the banking market. Given that banks borrowed €489 billion from the ECB last week, don’t hold your breath about that expanding credit either.
These stresses are all despite UK bank deposits being at record levels.
Andrew Tyrie has made a complaint on the liquidity rules impeding lending, but the data from the Bank of England shows the opposite.
Deposits in August 2011 were almost 220 per cent of GDP. In 2006 the number was 196 per cent of GDP, and it fell in 2007 to 181 per cent of GDP as part of the overall credit crunch. Clearly, this 181 per cent level is the danger level where we should worry, but we remain 40 per cent of GDP away from it.
Because banks can’t refinance their own borrowings, their only alternative is to start reducing their number of loans.
The first stage of this is selling loans and investments, and this is what banks had started doing in October when we reported on the signs for a banking crisis. However the report from the market is that the selling has reached an impasse. Marketable securities are not so marketable. So banks must look elsewhere.
The second stage of the reducing loans is to put pressure on other businesses for those businesses to repay. We are now seeing evidence for this in the UK, and this is the real flashing red signal of a coming crunch. This is the liquidation stage of deleveraging.
Take RBS for example. It has managed to detonate two debt bombs in the last month. First at DTZ, a company that was once worth £500 million, that is now worth only £8 million. RBS called in advisors in September to look at how RBS could recover its loan.
A fortnight later, RBS was one of the banks that asked Thomas Cook for its loan back. Since then, Thomas Cook has negotiated a £200 million line from the bankers, but it’s not that it hasn’t had to sweat. RBS, HSBC, Barclays and Unicredito (the number one Italian bank) are all lenders to Thomas Cook.
This isn’t isolated to RBS. Last month saw another retail story related to one of HBOS’s largest borrower, Arcadia, the holding company of Philip Green’s Topshop retail empire.
Back in October 2005, Arcadia borrowed £1 billion in October 2005 (£) so that it could pay Sir Philip’s Monaco-based wife a £1.3 billion dividend. The financing was in the form of a seven-and-a-half year loan from HBOS, Royal Bank of Scotland, HSBC, Barclays, Lloyds TSB and Bank of Ireland.
Over the last few years, Arcadia has steadily paid down the debt. In 2010, he had said he had a target to pay down Arcadia’s debt by 2012. At that time, the Arcadia’s debt was £464 million. Sir Philip was very confident that he would be able to get to zero debt by 2012 – that’s the deadline on the loan.
However, a month ago Sir Philip announced that while Arcadia remains profitable, profits were down 38 per cent, and additionally in the accounts it’s possible to see that this year Arcadia was only able to repay £19.5 million back of the loan. He has two years to pay back the remaining £444.5 million.
This pressure to repay provides an alternative explanation as to why Sir Philip announced he was closing 260 stores. It may seem perverse that Sir Philip is reducing revenues to pay off debt, unless his announcement of exiting the 260 stores is his opener for negotiations for lower rents on the store leases.
A lower rent cost will have the effect he needs which is to generate enough profits to pay down the loan by 2012. Given that Arcadia’s profit for the past year was only £190 million, he’s got to take some actions if he going to pay back the remaining debt by 2012.
These threats are a sign of the pressure the whole business sector is under, now that loans are no longer available from the banks. In 2005, Philip Green could borrow a billion for a dividend. Now he knows he must repay. But these isolated cases are just the pre-tremors of the earthquake we’ve warned is coming.
In November, the incoming Chairman of the Financial Stability Board made his first speech on this topic, predicting that Eurozone banks would reduce their loans in the next two years by between $2-3 trillion.
Morgan Stanley, reproduced at the FT Alphaville (£) has produced analysis of which country is most exposed. The reduction in UK bank balance sheets is expected to be the second highest after Germany.
German banks are expected to reduce loans by €500 billion, UK banks by €400 billion. This doesn’t take into account home-bias in the loan reductions. In a year with many forms of economic protectionism, we can expect that it won’t be German companies that the German banks look to get cash back from first, it may well be in the UK.
As we warned in October, the coalition’s banking policy has left us completely unprepared for the coming storm. Their postponing of any change to banking regulations has left the banks exposed. Their pursuit of austerity at the expense of growth means that UK companies are struggling as it is, without having to worry about paying back bank loans.
It’s difficult to calculate the real economy effect, because one never knows when governments will step in and intervene. The problem for policy makers is that no-one can predict which company is next to be under threat. No-one can predict whether that company will find a lifeline (Thomas Cook did, DTZ didn’t). No-one can predict when it will stop.
The most recent small-ish liquidation we’ve seen was the recent Icelandic bank collapse sent shock waves through retail, as the receiver tried to recover money from borrowers. The major collapsed bank, Kaupthing bank, had a balance sheet of €55 billion.
UK banks will deleverage seven times that much. It will represent a five per cent reduction in the lending of UK banks, and depending how quickly it happens, the output drop could be one for one – a per cent drop in UK output in 2012 as a result.
There is a solution for the UK banks and that is a repeat of the Labour government’s 2008 package of capital raisings, debt and liquidity guarantees. There is minimal cost to the tax payer, UK banks were properly capitalized in 2008, and the European Banking Authority that regularly updates its stress tests persistently puts the UK banking sector at needing zero capital.
Therefore, all that is needed is for the UK government to restart the scheme again for UK banks. However, there is no pressure to do that from within the coalition government because the coalition’s narrative relies on this package having been a mistake. It will turn out to have been a much bigger mistake that they didn’t do that. Liquidation is coming in 2012.
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• The UK isn’t Greece, it’s Iceland – Alex Hern, December 21st 2011
• Implementing Vickers won’t stop the next crisis – Josh Ryan Collins, December 20th 2011
• Cameron’s excuses don’t add up – Cormac Hollingsworth, December 13th 2011
• Trouble ahead for Cameron: Majority of Euro rebels were from class of 2010 – Shamik Das, October 25th 2011
• A damp squib or quiet radicalism from the Vickers Commission? – Ben Fox, September 13th 2011