by Raphie de Santos
Is The Crisis Over?
Over the last two weeks there has been lots of telling economic and financial data from which some commentators have drawn the conclusion that the worst of the economic and financial crisis is over. We set out here to examine this data and determine if these commentators are right by looking at the banks, stock markets, the Bank of England and global economies.
The four major banks and the wholly state owned Northern Rock reported their results, which were described as mixed, during the business week ending the 7 August 2009. We show these in the table below - all the figures are in billions of pounds sterling.
Barclays HSBC Lloyds RBS* Nthn Rock
Pre Tax Profits 3.0 3.5 -4.0 0.2 -0.7
Write-downs -4.6 -9.6 -13.4 -7.5 -0.5
Banking Profits 1.0 4.2 0.0 5.1 0..0
Profits ex 2.0 -0.7 -4.0 -4.9 -0.7
*RBS Suffered a post-tax loss of £1bn
The points of interest are: only Barclays made a profit when investment banking revenues are excluded; and the revenues from investment banking are a one off. Stock markets have rallied by nearly 50% from their March 2009 lows and the price fluctuations – called volatility – of financial assets have fallen making derivatives easier to trade and reducing daily profit and loss moves. In the credit markets the cost of buying insurance against bankruptcy has also fallen. All these factors have combined to create bumper investment banking profits. Normally stock markets would move no more than 10% over such a time span. But as we show later the sharp rally we have just seen is common in stock market crashes. In the past these have proved to be false dawns – often called sucker rallies - with the market falling again to levels below the previous lows.
The write downs in six months are nearly £36 billion. This money was lost as the value of assets the banks hold and loans to individuals and companies were written off. These losses are not paper losses but have to be matched from the banks capital. These are the losses from the banks exposure to the recession. They will continue dripping losses of this magnitude while the recession lasts and house prices continue to drop. If you add a major market fall and an increase in asset volatility, then on top of these losses will be potentially huge daily losses from derivatives – banks globally have a $700 trillion exposure to these assets. Such a scenario would lead to a similar financial meltdown as we experienced September 2008.
Even without a market correction the banks are likely to all return losses in the second half of 2009. The write-downs are probably underestimated as new rules give the banks leeway in accounting for “difficult to value assets”.
The Stock Markets
Stock markets around the world have risen by over 50% (to week ending 7/8/2009) from their low point in March 2009. Stock markets are where companies’ ordinary share capital (shares) is traded. They are usually seen as a leading indicator of what is happing in the economy. So does this rally mean that the worst is over for the economy and the banks in particular?
If one looks at the history of severe economic recessions a pattern emerges: after a sharp fall in share values over several months, shares make a partial recovery in the hope that the worst is over only to be disappointed and fall again to reach new lows.
In the 1930s depression shares fell from a high of 380 on the US Dow Jones Average (DJA) to a first low of 199 over two and a half months only to rise 48% to 294 five months later. This proved to be a false dawn as US credit dried up on the back of its banking crisis driving the world into a deep depression. The DJA then fell 89% from its all time high to a low of 41 two and a quarter years later.
Sounds familiar? This time the DJA took one and a half years from the credit crunch breaking to fall 54% from its pre-crash high. It has since rallied 44% to its close on 7/14/2009 of 9435. In the UK the initial fall was of the same magnitude but the rally less pronounced to 34%.
The rally – known as a sucker bear rally – in shares is as we write (17/8/2009) is running out of steam. We are likely to see a sharp fall in shares as the markets wake up to the effect of the “end of credit”. This will lead to an increase in the price movements of all financial assets and a big rise in financial volatility. The banks who therefore made gains in the first half of 2009 will suffer steep declines in profits as their exposure to $700 trillion worth of derivatives will create huge losses similar to those they experienced in the autumn of 2008.
Governments would then have to again step into bail out the banks but this time their scope for action is limited by the amount they have spent already and the steps they have to take to find the money to pay for it.
The Bank of England
The Bank of England (BOE) has made two important statements over the last two weeks (3/8/2009 to 16/8/2009). The first was on quantitative easing and 2009’s second quarterly report on inflation. These statements revealed more about the state of the economy and the financial system and its future than any vague optimistic comments that have come from government and City’ analysts.
On quantitative easing the announced that they would raise the total pot to £175 billion – an increase of £25 billion of which £125 billion of the original £150 billion has been used already. The new unused total of £50 billion would be put to use over the next few months. The £175billion represents 12% of our economy (gross domestic product - GDP) and together with other bailouts will take the total of our money spent by the government and the BOE on saving the banks to £350 billion or nearly 25% of our GDP.
Quantitative easing is a tool where the BOE of England prints money and buys back with this money government and other debt from Banks, Financial and other institutions. The idea is this will give the financial system money that they will then pump into the economy in the form of mortgages and loans to consumers and buinesses. All the evidence points to this not happening and instead the financial sector is hoarding the money as a buffer against further looses on mortgages, loans and derivatives.
The table below bears this out. It shows, in billions of pounds, the average monthly personal debt for 2006 – the last full year before the credit bubble burst, the average for 2009 and the figures for the latest month where data is available - June 2009.
Loans Secured Consumer Mortgages Re-Mortgages
On Homes Loans
June 2009 0.3 0.1 6.2 4.3
2009 1.0 0.1 4.6 4.1
2006 9.2 1.1 16.0 11.5
One can see the massive fall off in credit from 2006 that has driven the UK economy into recession. In June 2009 only mortgages – which account for bottoming out of houses prices - are significantly above the average for 2009 which is way below 2006’s average. Of the £125bn of quantitative easing only £1.7 bn has found its way into additional credit!
Why then spend another £50 billion on quantitative easing? The answer can be found in quote from BOE governor Mervyn King in an interview on the recent BOE inflation report. He said that the banking sector was still “in a very bad way” and predicted it would take years to “repair balance sheets” and wean the banks off public support.
In other words quantitative easing is nothing but another bank bail out that we will have to pay for through cuts in public services, wages and jobs and higher taxes. As well as quantitative easing the Royal Bank of Scotland and Lloyds TSB/HBOS have insured over £700 billion of their toxic assets – loans and derivatives – with the UK government, This means we will be liable for further losses which are likely to mount in the second half of the year as we pointed above on the section in banks. The future maximum bill we will be presented with and paid for by us through cuts and higher taxes is unknown.
The UK economy and is still in decline only the rate of decline has slowed. Unemploymnet contuses to rise with nearly 20% of 16-24 year olds unemployed. In the US official unemployment has fallen slightly although nearly 250,000 lost their jobs in July. This is mainly because millions have given up looking for work. Those claiming unemployment benefit are 9.4 % of the total US workforce. But the national labour office estimates that nearly 30 million are out of work which is nearly 20% of the national workforce. Consumer confidence continues to fall in the US and inventories of goods are also falling at a rapid rate. This shows that US corporations are unwilling to produce more goods as they no faith that they can be sold. Only government subsidies for the car industry have boosted production slightly.
US corporations’ economic results are only being held up by huge cost cutting programmes. Underlying sales are poor and once the one off effect of cost cutting passes their results will start to deteriorate
Outside of China only France and Germany, in Europe, and Japan have managed to stop the decline in their economies. This is mainly because the French and German governments had to spend less on bank bailouts and were able to put funds into stimulating consumer spending and the infrastructure. These economies had also much smaller level of consumer debt and a smaller housing bubble. But the stimulus is likely to be a one off as European banks losses will increase in the second half of the year as exposure to eastern European and emerging market property loans hit their balance sheets. They also have exposure to derivatives and there are likely to be losses in this area in the second half of 2009 and not the windfall profits that accompanied the stock market rally since March of this year. Outside of Germany and France, economies with a large housing bubble have been hit hard – Spain and Ireland primarily.
The Japanese economy grew 0.9% in the second quarter of 2009 below the median forecast of 1.0%. This ended 15 months of successive contractions with the sharpest in the previous quarter when the economy shrunk nearly 3%. The growth in quarter two was driven by a $2 trillion government stimulus programme and exports. But the financial markets believe the effect of this will be short lived as the stimulus wears off and the global economy continues to shrink in the third quarter of 2009 leading to a decline in exports. On day the figures were announced (17/8/2009) the Japanese stock market dropped 3%.
China though technically not in recession has seen tens of millions of people made unemployed over the last two years. Only a massive stimulus programme driven by the central government has kept its economy afloat. Nearly $3 trillion of new consumer debt has been created in the first half of 2009. But the government are turning this tap off as they see the first signs of a speculative bubble in property and the stock market. Of course this internal stimulus programme does not help the rest of the world’s economy apart for the commodity industries as China is a huge net exporter. And these exports continue to decline as the world’s overall economy continues to shrink.
The global finance system is so contaminated with bad debt and derivatives that we are likely to see years of declining and stagnant economies. Unlike the 1930s the crisis of credit is not a US one but a global one with the banks also geared up to derivatives which can bring the financial system to the point of collapse when the financial markets decline and volatility in financial assets increases as we saw in the Autumn of 2008.
This means governments will have to continue to use our money to bail the system out rather than create jobs and services. The majority of us will pay for these bailouts through public service cuts and tax rises and unemployment.
But there is an alternative which means taking the banks under our control and neutralising their rotting loans and cancelling their destructive derivative contracts. It means a society where resources and wealth are shared to meet human needs. It is the only rationale alternative to the harsh future that capitalism offers us.