Monday, March 17, 2008

Lessons From The Bear



Not a bear to follow

What can British taxpayers learn from the Bear's collapse into the arms of JP Morgan?

First, let's note the similarity with our own dear Crock. Here was a bank that was no longer able to borrow from other banks and wholesale lenders, and which has an unknown amount of dodgy loans on its balance sheet. It could not survive without taxpayer support.

Now let's note the big BIG difference- the US authorities gripped the problem and got it sorted over a weekend. They simply opened their old smoke-filled room and bashed through a solution.

Yes, to get swift action they had to leave the Bear shareholders with a small amount of equity, but it's only 1% of its value 12 months ago. And yes, they've had to make a $30bn loan against some pretty dodgy collateral, but it's only for a month. And yes, JP Morgan shareholders will get all the upside, but they've also taken on the bulk of the risk.

Contrast that swift action with the Crock case. Our authorities faffed and blundered around for six months, having rejected a JP Morgan style rescue from Lloyds TSB last summer. They hoped somehow something would turn up, even though everyone else could see their prospective buyers were mainly after taxpayers' money. And all the while the situation deteriorated further.

The key reason for the difference of course is the half-baked Brown/Balls regulatory reform of 1997. As we've blogged many times (see previous blogs gathered here), because of the ill-defined way they split responsibilities between the Bank of England, the FSA, and the Treasury, nobody was at the controls when the Crock hit the wall.

Despite a decade of crowing about Bank independence, when it came to dealing with bank failure, Brown had emasculated the Bank of England.

In contrast, the US Fed retained its traditional clout: yes, they only ever take such extraordinary action in concert with the US Treasury, but they still have the credibility to get the politicos on board (for a good account see Alan Greenspan's book The Age of Turbulence).

Which approach is best for taxpayers?

Clearly, taxpayers on neither side of the Atlantic would start from here. We're all now on the line for guaranteeing rafts of questionable assets built up in the global debt bubble.

But whereas we British taxpayers are exposed to the full £100bn plus of Crock debt, US taxpayers are "only" holding $30bn of dodgy Bear assets. The risk on everything else is being born by the shareholders of JP Morgan (OK, OK, that $30bn is likely the most toxic stuff, but the plan is for JPM to examine it over the next 30 days and take it onto their own balance sheet at a suitably marked down price- ie resolution).

With the debt crisis worsening by the day, the government must crack on with its new banking legislation. But as taxpayers we should rue the day Brown decided to stymie the Bank of England's power to run its own smoke-filled room. The room that had been used for decades to twist arms and engineer cut-price take-overs of ailing banks. The room that had prevented High Street bank runs for 150 years.

Financial market confidence is a fragile thing. And it is often beyond the kind of abstract academic analysis so beloved of commissars like Brown and Balls (again, see Greenspan for his reflections on that notorious irrational exuberance remark). Smoke-filled rooms might be dark and stinky, but in the real world we abolish them at our peril (also see here for good John Gapper blog).

The outlook is pretty grim. It's most unlikely the Crock and the Bear will be the last casualties of the deflating debt balloon. Taxpayers could end up holding A Lot of dodgy debt.

And just to put some scale on that, the total liabilities of UK banks currently stand at over £6 trillion, or four times annual GDP. Gulp. Of course, nobody's suggesting it's all dodgy. I mean, lots of it is lent to other banks, or secured against property, which is... er rock solid.

Sleep well.

PS The crisis is bringing out every old financial cliche in the book. The good old tax-funded BBC this morning was full of Dave Spart language about "workers" versus "money lenders". But we like this bit from the New York Times: "A throwback to a bygone era, Bear Stearns still operated as a cigar-chomping, suspender-wearing culture where taking risks was rewarded. It was a firm that was never considered truly white-shoe, an outsider that defied its mainstream rivals." Gotta love those white shoes.

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