The Crash! – 10 years on… The memories remain vivid!
By David Buik
If I was forced to lay the blame for the apocalyptic 2008/9 financial crash and the deepest recession since 1929 at one person’s feet, it would unequivocally be at former Federal Reserve Chairman Alan Greenspan’s. Why? He had been at the helm of the Fed since 1987 and had handled the financial whips and scorns of time relatively deftly. However, the advent of the Bush administration in 2000 crystallised the possibility of a major recession in the US. Consequently, Greenspan encouraged all American banks to lend every ‘nickel and dime’ they could lay their hands on to every ‘John Doe’, particularly if he/she wanted to buy a property in the likes of deepest Nebraska. There was doubt that many of these borrowers had the capacity to either service this debt or repay it. The fact that there were inadequate regulatory controls didn’t help and the situation was exacerbated by the Glass Steagall Act being revoked in 1999.
This may sound like a harsh appraisal. However, at that time, investment banks around the world, particularly in the US, had learnt how to use derivatives to full affect as well as the innovative ability to package these loans up in to small parcels, which were easy to sell to unsuspecting wealthy retail investors. The packaging came from loans transacted by the banking fraternity as well as by Fannie Mae and Freddie Mac. This was sub-prime lending at its most virulent.
In 2002 HSBC paid $14 billion for a subprime operation called Household. By 2006 HSBC, to its eternal credit, flagged up that this style of lending may not be all it was cracked up to be. Bad debts were increasing by the day. Throughout 2007 anxiety over the robustness of the world’s banking system was growing.
By March 2008 the US Treasury Secretary Hank Paulson rattled JP Morgan’s Jamie Dimon’s cage, imploring him to take Bear Stearns off the street and into JPM’S portfolio. Bear Stearns was all but insolvent through its involvement in mortgage lending and related bond activity. JP Morgan paid $2 a share amounting to $236 million and in September 2008 JP Morgan swept up Washington Mutual for $1.9 billion. The situation was becoming alarmingly acute by the day. On 15th September Lehman Bros finally went down for $50 billion on $600 billion worth of assets. It’s very easy to be wise after a catastrophic event of this magnitude. However, Paulson’s decision not to bail out Lehman Bros, which presumably had Ben Bernanke’s – the new Federal Chairman – backing, proved to be an act of folly. Why? The many international banks which had transacted thousands of deals with Lehman Bros had no opportunity to cross these deals. Consequently, the losses incurred by the financial fraternity were much greater than they should have been.
Not only were banks becoming deeply involved, but so were insurance companies and specifically AIG, which was bailed out the following day for $85 billion. The toxic effect of the collapse in the global banking and credit crisis was felt right across the world. Unemployment in the US rose from 4.7% in 2007 to 9.8% in 2009, the equivalent of 14 million people unemployed. The subsequent recession was very deep. On 29th September 2008 the Dow Jones fell 777 points – the largest drop in any single day in history.
We should now look at the help provided by the Fed to the banking sector in the form of quantitative easing. Initially it was $700 billion which was wholly inadequate. However, it was added to on a regular top up basis. On 3 October 2008 the “Troubled Asset Release Program” was introduced by the US Treasury and the Fed. Every bank was forced to participate, even the great Goldman Sachs and JP Morgan! Even though the recession was probably deeper in the US than anywhere else in the western world the recovery, due in the main to quantitative easing, was more rapid. Credit should also be given to the Dodd Frank Act which saw regulation change more dramatically and quickly than it was in the UK and Europe. Just look at the way Wall Street recovered! – Dow Jones from 6626 on 6th March 2009 to 25995 on 7th September 2018 – up 292%. The NASDAQ composite from 1293 on 6th March 2009 to 7922 on 7th September 2018 up 512%.
So much for the United States! Here in Old Blighty the situation was just as desperate. The first sign of financial stress the public was subjected to was in September 2007 when the BBC’s Hugh Pym took a stroll down Moorgate to see the queues lining up outside Northern Rock PLC. I accompanied him as at the time I was BGC Partners’ market commentator. People were panicking until Chancellor Alistair Darling made it clear that depositors would be paid in full up to £81,000. Then the queues disappeared. Though Gordon Brown in his heyday was a decent Chancellor, he was entirely wrong blaming sub-prime lending on the banking and credit crisis in the UK. It is generally accepted that RBS was injudicious in paying a gargantuan £26 billion for the investment banking division of ABN AMRO. This was a ‘pup’ laden with bad debt, which might easily have fallen into Barclays’ lap at a lower price. Apart from that deal the demise of the banking sector was almost entirely due to poor credit analysis and soft regulation which both Labour and the Conservatives were surprisingly comfortable with. Bank balance sheets just grew ridiculously, with RBS allowing its balance sheet to reach £2.2 trillion – larger than the Government’s balance sheet of the day – aided and abetted by copious acquisitions made all over the world. In the case of HBOS its lending to property requirements was bordering absurd.
Northern Rock was really the catalyst of the collapse of the UK’s financial system. In August 2008 it went down for £3 billion. Adam Applegarth, Northern Rock’s ebullient and bombastic CEO, was allowed together with its naïve and ill-disciplined board to agree mortgages over 100% of the property’s value, whilst borrowing short-term money. Many of these people who borrowed never had the capacity to service their debts in the property market, that was on fire. The bad debts of Northern Rock were eventually garaged in the new Government arm – UK Financial Investments. Chancellor Darling was inspirational at grasping the nettle with this initiative and the troubled waters were temporarily calmed.
In April 2008 RBS went to the market for a £12 billion rights issue to pay for ABN, which investors bought hook line and sinker. Within weeks the share price of RBS had halved. In July 2008 HBOS went to its shareholders for £4 billion, the same happened. By November it was near enough all over for both RBS and Lloyds Banking Group, whom we understand was persuaded by the Government to take in HBOS in to its portfolio, with indecent haste, to avoid the embarrassment of another bank going in to public ownership. Both were bailed out by the Government for circa £75 billion.
As we know all know, Lloyds is now out of the tax payer’s control with a small profit, though it took nine years. RBS is still underwater. The break even for the tax payer is 503p. The current price is 242p. The likelihood of the tax payer getting its money back is zero. RBS, since 2008 has lost over £100 billion and now that the litigation seems to have finished, one suspects that the Government will unload the taxpayer’s stake within the next two years to private enterprise. Had Barclays not arranged a cash injection of $8 billion from Qatar, the ‘Bald Eagle’ could well have found itself in the ‘lifeboat’, despite between 50% and 60% of its profits emanating from Barclays Capital, its investment banking division, over the previous decade. Subsequently, the legitimacy of this injection is being challenged in the high court. HSBC, thanks to its global diversity avoided official help, though access to central bank liquidity and QE was essential. At the end of the day ‘Household’ eventually cost the ‘local bank’ over $50 billion in losses!
The road to recovery in the UK has been painful. However, few could begrudge significant praise to Lord Mervyn King, Sir Paul Tucker and colleagues for the brilliant, undemonstrative and calm manner they handled, on behalf of the BOE, the liquidity required to get the banking sector back on its feet. I think few people realise how close the UK was to financial Armageddon – I am not exaggerating. Quantitative Easing to the tune of initially £425 billion rising to £475 billion gave the market the fillip for renewed confidence to the financial system overall. The FTSE has rallied from 3,530 on 9th March 2009 when QE was introduced to 7,278 on 7th September 2008 – up 106%, a mere bagatelle in comparison to the US markets. However, QE was a necessary evil, stimulating a renaissance of confidence. Frankly, it was an exercise in ‘free money’ that raised the spirits of the banks, enabling the economy to gird up its loins, whilst a few people made a shed load of money. Mind you QE in the UK was ‘small beer’ in comparison to the US facility, which totalled $4.5 trillion! What no one knows is what the ramifications and fall-out from QE will cost.
The damage to society from the recession has been virtually irrevocable. Unemployment rose from 5.7% in 2008 to 8.5% in 2011. So many people lost their jobs, their houses, with many families destroyed. Unsurprisingly there has been a massive manifestation of resentment, anger and bitterness towards those responsible for the collapse of the economy – a few greedy bankers, poor regulation and inept politicians, who allowed the banking sector’s balance sheets to grow by ludicrous proportions. So much has been written about RBS’s Fred Goodwin, his Chairman Sir Tom McKillop and HBOS’s Lord Dennis Stevenson and James Crosby. Their incompetence and lack of judgement knew no bounds. Two issues have upset me. Firstly, no senior banker has ever been brought to book; it’s always “the oil rag rather than the engine driver” that has been blamed and punished. Finally, there has been too much banker bating. This has been counterproductive for the recovery process. Only very few people behaved badly. Not all bankers are pariahs.
The recovery of the economy has been anaemic at best, though unemployment is now down to 4%. However, the well to do have become richer and those that had little seem to have less! The UK took a long time to grasp the regulatory nettle with Gordon Brown looking for guidance from the European Union. Why? I have no idea, as the EU has been even slower getting to grips with its banking sector. The EU only introduced QE in 2015. The UK wasted so much time with Gordon Brown initially prevaricating in making decisions. He grew in to the crisis well. However only two people really came out of this crisis with their reputations in tack – Lord Alistair Darling who was a cool, calm and collected Chancellor all the time and in the background Lord Paul Myners, whose commercial savvy proved value for money.
From 2010 Chancellor George Osborne was seen in a very positive light, in terms of leading the country out of economic bondage. However, though not George Osborne’s fault, there is little doubt that low interest that prevailed for a decade and the need for QE, a ‘necessary evil’, have seriously damaged savers. Savers are an essential ingredient for a strong economy. It has also wrecked pension schemes and may well have damaged investment for the recovery process.
Under the stewardship of Lord Mervyn King initially and subsequently Mark Carney, the Bank of England has been extremely diligent in regulating the banks. Each bank requires almost ten times the amount of capital to do the same business it did ten years ago. Andrew Bailey as head of Prudential Banking masterminded these changes and last year was appointed Managing Director of the FCA.
What have we learned from this financial meltdown and could this happen again? Despite a like-warm economic recovery, UK banks have proved to be a poor investment for some years. Not only did the banks’ trashed balance sheets prevent recovery, but there was a small matter of PPI payments which cost the banks £30 billion. Again, this proves that aggressive sales, greed and poor regulation have been just as toxic as casino banking, as Sir Vince Cable likes to refer to it as.
Those of us who worked as brokers in the money markets knew by May 2007, that there was “trouble at mill.” As wholesale money brokers at BGC Partners, we, like other leading parallel companies were unable to provide little, if any deposits for Northern Rock, Bradford & Bingley and Alliance Leicester Building Society. The information board in our dealing room just said ‘SHOW ME THE OFFER’ in red ink! The Bank of England knew the difficulties these mortgage banks were having raising funds. Confidence in the wholesale deposit market started to dissipate by the day. By the beginning on 2009, it was all but non-existent. There was an eerie feeling across the city. The noise of frenetic and hysterical trading grew daily, but it was interest rate swaps, FRAs, foreign exchange and bond trading that created the cacophony of noise, not the old-fashioned interbank deposit market! At times pandemonium prevailed!
Throughout 2008/9 I was a frequent commentator on television and radio on the banking crisis and credit crunch – often appearing six to eight times in a day, such was the dearth of choice. These appearances were not down to any specialist talent or prowess. It was because few representatives from the banks themselves were prepared to comment, in case their situation was prejudiced or compromised. I remember BBC Today’s John Humphrys very frustratingly appealing for a banker to come forward to discuss the issues of the day with him, whilst I was in the studio. It never happened until much later.
Could what happened in 2008/9 ever be repeated? – unlikely but possible. Regulation is much tighter than it was, particularly tough banking ‘stress tests’ being constantly revised and implemented. However, I am disturbed that President Trump seems comfortable relaxing regulation in the US. Asia and particularly China has so much growing and expansion to deal with. Together with the economic explosion taking place on the sub-continent, it will be hard to keep the lid of safe regulation, particularly in the wake cyber-crime, which makes the global banking sector look vulnerable. Remuneration is still far too high, but the fact that bonuses are now paid mainly in share options rather than cash should lead to greater stability and the ability to take rewards granted back, if profitability proves to be erroneous. The Daily Mail’s James Burton makes a strong comment today that the reputed £178 million the bosses of four largest UK banks have earned, is wholly unacceptable. In isolation this is true. However, in international markets, quality people cost money and the need for a number of these specialised operators was essential to get these banks back on their feet. Consequently, the bosses are in neon lights. If the job gets done by the professionals, then the bosses will want their pound of flesh. In the case of Stephen Hester and Ross McEwan, they have never been seriously remunerated for their thankless task.
In closing it worries me that the bank manager is becoming an endangered species. To compensate with much tougher capital requirements banks are relying too heavily on technology with a view to cutting costs. I find it hard to reconcile making decisions on loans to clients – both corporate and consumer – without seeing the whites of their eyes. The Bank of England’s Chief Economist, Andy Haldane has spoken very eruditely of the dangers of a technological revolution, which could savage jobs. Let me chuck my ‘two cents worth in’ – human contact in banking is a fundamental requirement! This is more than just a warning!
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