Vericool Finance

Swine flu, a major bankruptcy, rumours of big holes in US bank balance sheets… last week looked like “yet another shocker” to add to all the others that have roiled the financial system.

Not so long ago, any one of these events would have wiped billions off stock markets; together they would have caused catastrophe. But something has changes.  Traders seem bent on shrugging off the bad news and continuing a winning streak that has lasted almost two months. As Richard Dunbar of Scottish Widows observed on the BBC Radio 4 Today programme, “the market has moved from 100% fear to 100% greed” in six weeks flat.

This feels like a pivotal moment in 2009’s titanic battle between bulls and bears, and the bulls would appear to be in the ascendancy.  Equity markets across the developed world have jumped by a third; emerging stocks are on fire; and risk indicators are retreating.  Three-month Libor (the inter-bank lending rate) dropped below 1% this week, reflecting banks’ willingness to trust each other again.

Meanwhile the big guns are out in force, reiterating their conviction that the good times are rolling again.  Hedge fund manager Crispin Odey, who made a fortune shorting bank shares on their way down, has reportedly made another mint after buying them at the bottom, and he’s convinced the rally has only just begun.

Investors, like policy-makers, are betting that optimism will prove self-fulfilling. Clouds become mere appendages to big silver linings. As for unequivocally bad news – a huge increase, or confirmation that UK house prices are still falling – it is simply ignored.  Investors seem to be on a mood-enhancing drug.  And, in a sense, they are.  Governments and central banks have been issuing vast quantities of a stimulant (cheap money) that gets markets high.  But the drug is still in trials, and may yet have adverse side-effects.  Try soaring inflation, for starters.

There’s now a risk of a massive trap for unwary investors. Having preserved their money after the first big crash, they are now being set up to lose it in the next one. The economy is still in deep trouble and markets cannot ignore that fact forever. The most that can be said at this point is that financial Armageddon is no longer looming. If that’s true, it may well be worth 20% on share prices, but is can’t create a sustained bull market.  For that to happen, more good news is required.  Recoveries in the real economy tend to require something more substantial than a handful of semi-cheery surveys.

Spring has come to Washington and, with it, the sickly sweet smell of scandal.  Or was that the smell of blood?  The public outcry over the sickening $165m in bonuses paid to AIG executives is certainly justified:  some of the recipients – particularly those working in the specialised London unit whose creative gimmickry effectively sank the company – are more worthy of jail cells… than new vacation homes.

At $182bn and counting, they’ve cost the US taxpayer dearly.  Yet the tabloid-fuelled outrage came dangerously close to becoming the lynch mob.  Several executives reported death threats (one involving piano wire), and the mood was scarcely less violent in Congress, where one senator said he hoped executives would follow the Japanese example and “go commit suicide”.

That remark was later laughed off as rhetoric, but Congress was deadly serious in its quest for revenge.  In its bipartisan rage, the House saw fit not merely to punish the employees of AIG’s financial products unit, but to vote in a 90% tax on the bonuses of anyone at every bank receiving $5bn in taxpayers money who earns more than $250,000 a year.

A draft Senate version of the bill is even broader.  Never mind if the bonus was earned last year or earlier, or under a legally binding employment contract.  The confiscatory tax will apply ex post facto. It is certainly one of the more amazing and senseless acts of political retribution in American history.  Few stopped to debate the potentially ruinous effect this might have on the financial system, let alone the rule of law.  Obama needs to face down the AIG mob, or his presidency may become the next victim.

Obama is clearly uncomfortable with the legislation, but he should do more, and actively oppose it:  not least because his Treasury Secretary, Timothy Geithner, desperately needs the private sector to support his new bank rescue plan.  What’s the incentive for private investors to risk buying toxic assets if any gains are later confiscated?

The situation was partly defused when AIG reported that most executives had handed back their bonuses.  But the stakes remain high.  The Treasury plan assumes that the basic problem is one of liquidity: it aims to create a market for securities that are currently not trading.  But if the problem is really one of solvency – that these assets are worthless after all – all bets are off.  Emotion is high on both sides.

Wall Street is raging against the dying of the light and Congress is responding to populist rage.  Those emotions could yet derail this plan.

The gumshoes at the US securities and Exchange Commission are none too impressed by Allen Stanford’s knighthood.  They have accused the flamboyant Texan billionaire and cricket impresario of perpetrating a fraud of shocking magnitude.

But even if the title, bestowed by Antigua and Barbuda, is pukka, it may be the only thing about Stanford that is.  He is alleged to have run the Stanford international bank like a piratical Caribbean enterprise, gulling some 30,000 investors out of an estimated $9bn.  If the accusations stand up, it will be a severe blow to a fund management industry still reeling from Madoff.

The affair is also a kick in the balls for English cricket.  The England Cricket Board, which immediately severed relations with Stanford, insists it ran exhaustive checks on the tycoon before he lured the England cricket team into a circus of Twenty20 pyjama cricket with his own team, the Stanford Superstars.  Stanford was rebuked for the tacky quality of his competition, which offered $20m purse to the winning team, and for the inappropriate attention he paid to the cricketers’ wives and girlfriends.

But ultimately the ECB was swayed by his promise to counter India’s growing dominance of the commercial game.  Still, alarm bells should have rung from the moment that Stanford – a man with self-confessed loathing of Test cricket – touched down at Lord’s in a gold plated helicopter,.  Rumours of money-laundering had long been rife and it was clear to any sane observer that this was a tawdry business.  This affair has brought out the worst in English cricket and the men who run it. They have got exactly what they deserved.

The same cannot be said of the residents of Antigua, where Stanford has established himself, in colonial style, as the biggest private employer and business force.  His personal fortune dwarfs Antigua’s $1bn GDP and, if he goes down, the island’s economy could sink, too.

Yet Sanford’s other investors are not entirely blameless.  In the usual triumph of greed over fear, they missed a parade of red flags:  notably the promise that a unique investment strategy would consistently deliver double-digit returns from ostensibly low-risk investments.  The SEC, which was alerted by a whistle-blower, is yet to track down 90% of the portfolio, which it claims resides in a “black box” shielded from independent oversight.

It will have to do better than that.  The watchdog must now act urgently to address investor panic about how many more multi-billion dollar frauds have yet to be unmasked.

One thing that Hank Paulson learnt during his troubled tenure as US Treasury Secretary is that if you say you’re going to launch a bazooka, you’d better darn well do it.

Barely a fortnight into his new job, Paulson’s successor, Timothy Geithner, is in danger of repeating his mistakes. After months of ad hoc rescue plans, the markets hoped the new administration would deliver on its promise of a coherent, detailed plan to mend the financial system. What they got instead was strong on rhetoric, but offered little more than a bare-bone outline -and Wall Street threw its toys out of the pram.

The S&;P 500 fell 5% in the worst sell-off since President Barack Obama assumed office. Shares in Citigroup and Bank of America were hammered 15% and 19% respectively.

The chief problem with the $2trn bailout was that it fell between all the stools. It was neither well funded enough to recapitalise troubled banks, nor detailed enough to assure investors that the governmnet can solve the toxic asset problem - and there was a crucial lack of information about how each of these initiatives would work.

The reaction to the plan was a severe setback to the newly minted Treasury Secretary, who’d been hoping to gain some gravitas after a lengthy battle with Congress over his personal tax affairs, but there’s a good deal more at stake than Geithner’s reputation.

On some estimates, more than 1,000 US banks could fail over the next three to five years unless a credible plan emerges. Maybe the critics’ reaction to the plan was over-harsh. Who knows? This plan - once properly fleshed out - may end up working, but it would be unwise to count on it.

The lesson of all previous banking crises is that the problem isn’t properly lanced until the system is fully cleansed and suspect assets fully removed. Ideallogically, Americans are vehemently opposed to nationalism, even more than Britons. But when there is so much money already being used to prop up the banking system, what’s the difference?

Geithner now says he’s consulting to fill in the missing gaps. If that’s the case, why were we led to believe that a completed plan would be delivered this week?

The markets would forgive a delay caused by the desire to get the details right, but they don’t like being misled. Raising hopes and under-delivery may be standard procedure in the political sphere but it doesn’t fly in finance.

This was a catastrophic failure of expectation management that bodes ill for the new administration.

Global leaders are caught in a dilemma: they face growing pressure at home to safeguard jobs and businesses, yet they know full well that if national considerations become paramount, our future is indeed bleak. It was the retreat into protectionism that blighted the 1930s, helping to create a worldwide slump and triggering political instability that led ultimately to WWII.

Who should we follow - Gordon Brown or Sir Alan Sugar. The PM says he’s “fighting hard” to halt a return to beggar-thy-neighbour trade policies and stresses the grave dangers of financial isolationism. But protectionist forces are already rampant. Spain’s industry minister has called on his compatriots “to shop Spanish”. In the US, pressure mounts for Buy America clauses in stimulus packages. And here, Sir Alan is telly Daily Mirror readers to “stuff the EU for a while until it suits us”.

But there’s every reason to be wary of such campaigns (which, when applied aggressively, are illegal anyway). Above all, they’re counter-productive.

We should avoid inflaming nationalistic counter-blasts from trading partners, particularly since, thanks to sterling’s weakness, British goods ought soon to be among the cheapest on international shelves. Buy British by all means, but beware the backlash.

There’s no reason why we should shun the grass-roots approach entirely. Britain’s localities need the power to drive their own regeneration.

The best means of achieving this might be a complete rethink on the role and use of the Post Office. The PO is a trusted brand, with a big but steadily declining branch network. Yet it is a massively under-used banking asset. Rather than privatising it, and further running down the network, why not turn each branch into a local finance hub, which would act as a vehicle for local investment and savings, and stimulate local economies?

Royal Mail has a £7bn pension deficit, but the PO is free of toxic debt. If the Government can underwrite hundreds of billions for the private banks, it can surely refinance £7bn for a public one.

We need a new parallel banking system. The Post Office is the obvious platform on which one could be built.

The financial markets were meant to view the UK’s second giant bank bailout as a path towards the resumption of normal lending. What we saw instead was open speculation on the chances of further nationalisation – and not just of the Royal Bank of Scotland.

During the turmoil, Lloyds HBOS lost 54% of its value in two days; and the markets were having none of Barclays protestations about how well it is doing either. The overwhelming impression is left that the banks still haven’t come clean about the risk on their books. And while that remains the case, private-sector investors will continue to pass on offers to pump in more capital.

The Government’s ambition of limiting the state’s involvement is well intentioned: the further we go in, the harder it will be to get out. But it should recognise which way the breezes are blowing.

A bad bank approach would have been a more direct and transparent method of quantifying and cleaning the smelliest items from the banks’ balance sheets. But maybe the Government was worried about seeing another multi-billion pound figure in the headlines.

The insurance policy is a politically palatable compromise, but until the details are clear it’s impossible to tell how adequate the package will be. That’s far from ideal : as every parent knows, “wait and see” is the least effective way of keeping impatient children quiet. Indeed, if Lloyds and Barclays are going to stand any chance of putting a floor under their shares, they must bring forward the announcement of their audited results.

Confidence is deteriorating fast and the Government’s scolding attitude isn’t helping. If Gordon Brown thinks nationalisation is the right solution, he should get on with it. But if he wants a commercially driven banking sector, he must start acting like he means it. You cannot hope to rebuild confidence in the banking system by constantly punishing its shareholders. No wonder investors are deserting the sector en masse. Ministers are doing their level best to make it worthless.

There are three main reasons why the Government might yet take control of the banks: to halt a bank run; to respond to the need for further capital injections; or to gain full control of bank lending to prevent the economy from falling into an abyss. As things stand, all three look inlikely. The market is pricing in survival probabilities of only 10%-20% fro RBS, and 25%-40% for Lloyds and Barclays, according to Bernstein Research.

A lot depends on the length of the recession and the generosity of the loss-guarantee scheme, but there’s still a chance of a rosier outcome.