The Banks, the Stock Market, the Bank of England and the Economy:

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 Banks

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

Investment
Banking Profits 1.0 4.2 0.0 5.1 0..0

Profits ex 2.0 -0.7 -4.0 -4.9 -0.7
Investment
Banking

*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 Economy

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 Future

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.

Darling printing money!

by Raphie de Santos

Darling in an interview in today's Daily Telegraph announced the government is to spend up to £200 bn on buying back government debt. This in effect printing money to try and drive interest rates down by pushing the yield on government bonds down by pushing their price up and pumping cash into the system so that it can be lent out. It's an admission that cutting interest rates has had little effect on the economy and the Bank of England monetary committee may not cut rates as expected this week.

Printing money is a short-term desperate measure as doing this for any length of time is:one,inflationary and two, adds to the public debt which has ballooned from 35% of our economy (GDP) before the out break of the crisis in August 2007 to nearly 48% now. At some point we will have to pay for all this from increased taxes.

Stocks fell again today as the new measures show the desperate weakness of the UK economy. The FTSE 100 touched 3500 at one point. The Left Banker is predicting that the the FTSE 100 will touch the 2000 level over the next 18 months if the stock market reacts in the way it did in the 1974 recession. A full depression will see it hit the hundreds. This of course will have a disastrous affect on working class as a large part of their deferred wages are in their pensions and insurance policies which are invested largely in the stock market - about 80% of the market is indirectly owned by the working class through pension and insurance funds.

Just another manifestation of the crisis of capitalism and how it is pauperising the working class.

More on Left Banker - www.leftbanker.net

Financial Crisis- what we need to know.

Click on picture below for article from Bill Newman and video discussion featuring Raphie de Santos, Bill Newman and Frances Curran.


More left coverage of the financial crisis at the LEFT BANKER site.

INVITATION - "THIS GREED WAS BEYOND IRRESPONSIBLE!"

YOU ARE PAYING!
WHAT’S THE ALTERNATIVE?

THE FINANCIAL CRISIS

—your questions answered.

THIS GREED WAS BEYOND IRRESPONSIBLE!

Kirkintilloch Leisure Centre Conference Room
Saturday 7th February, 10.30am– 12.30pm
Facilitated by the SSP co-convenor,
Frances Curran

Speakers—

Raphie de Santos— was head of Equity Derivatives Research and Strategy at Goldman Sachs International. He was an advisor on derivatives and financial markets to the Bank of England, London Stock Exchange, London International Financial Futures and Options Exchange and the Italian Ministry of Finance. Raphie has been a guest lecturer on derivatives and financial markets at Harvard and New York universities and the London School of Economics and has spoken at the annual Nobel Foundation conference in Stockholm.

Bill Newman spent most of his working life in banking, latterly as head of economics and then as Assistant General Manager of a City of London bank. For some 15 years he was also editor of and wrote for a journal on international monetary economics.
Bill was also on the Executive Committee and the Management Committee of the Banking, Insurance and Finance Union (BIFU) and a delegate to the TUC.

THE CAMPSIE BRANCH SSP invite your participation in this important discussion. How will this crisis effect YOU?

About the Scottish Socialist Party
While it fights to defend jobs, working conditions and living standards and for houses and health the SSP also demands a new economy.
Such an economy would start the task of harnessing the stupendous technological and material resources which already exist to meet the needs of society rather than the greed of the few.

This Greed Was Beyond Irresponsible

by Campsie Branch member, Bill Newman

Bill Newman spent most of his working life in banking, latterly as head of economics and then as Assistant General Manager of a City of London bank. For some 15 years he was also editor of and wrote for a journal on international monetary economics.

He has an interest in African matters, having been responsible for economic and political reporting on sub-Saharan Africa for Westminster Bank and writing for some years for the Europa Yearbook on Somalia and Ethiopia.

He was also on the Executive Committee and the Management Committee of the Banking, Insurance and Finance Union (BIFU) and a delegate to the TUC.

No. The headline above was not from the Morning Star, but was from that house newspaper for the rich and powerful, the Financial Times of 18 September. And how about these headlines from the Herald: Capitalism has proven Karl Marx right again and Bailing out banks is socialism for the rich. All this is true and reflects the intrinsic truth about capitalism, but you won't hear any MPs or MSPs accepting this or recognising that this profound crisis merely reflects the inevitable effect of uncontrolled capitalism, nor will they acknowledge that socialism is the answer to these periodic catastrophes. The press and politicians fulminate about the greed of financial traders and bankers and fail to recognise that it is this greed which is the rationale for capitalism. Without greed and exploitation, the whole structure of capitalism would collapse.

It may seem strange that apparently intelligent men could bring mighty financial edifices to their knees, but if you are earning stratospheric sums trading bits of paper to other overpaid traders, why worry that these pieces of paper might represent worthless or, at the very least, suspect commodities. Did no-one not bother to consider that sub-prime mortgages, for example, were, by their very nature highly risky loans and that by the time they had been packaged up with other dubious products, it was virtually impossible, once they had been traded time and time again on the financial merry-go-round, to tell what underlying value they represented. Some years ago when I worked in banking, I queried with the Bank's chief trader what the quantifiable risks in the derivatives he traded were. In reply he pointed out that the Bank made substantial profits from such trade and that all banks of any consequence were also engaged in this paper chase. In consequence, I raised my fears with the Bank's Board only to receive the same answer. In essence, the boom in these dubious trades was a classic case of pyramid selling, not unlike the South Sea Bubble, and only the greed of bankers blinded them to the escalating risks of these increasingly complex markets.

But do the travails of overpaid bankers affect the average citizen? Unfortunately they do and the coming months will show a massive decline in all economic activity as banks try to rebuild their balance sheets, refuse to extend credit and shed staff. It is impossible to believe, for example, the reassuring noises that Santander makes on employment in their subsidiaries in Britain. If Abbey, Alliance and Leicester and Bradford and Bingley are owned by the same company, is it credible to believe that these banks and their staff will not suffer from consolidation? Without access to credit, what is left of our manufacturing industry will shrink at an escalating rate, unemployment will soar and house price collapse will leave many with unsustainable negative equity.

So what is the response of our politicians? Inevitably, the bail-outs envisaged are bail-outs for the very people who got us into this fine mess, a fact that the American public has been quick to realise. Nor will the enormous sums involved remedy the sickness in the world economy. It is not surprising that our leading politicians seem to have no knowledge of Karl Marx who , as Ian Bell in the Herald pointed out, defined with precision the inevitable economic crises at the heart of capitalism. It is rather more surprising that they seem to have forgotten, if they ever knew, the lessons taught by Lord Keynes, so besotted have they become by the simplistic notions of the free market as propagated by American economists of the so-called Chicago School. It should surprise no-one, not even politicians, that the only UK bank to be trusted by the public at the moment is the only nationalised bank, Northern Rock; so successful that the Bank's deposit services have been curtailed! The lesson, which our politicians will not learn, is that publicly owned banks are secure and privately-owned banks are not. At the very least, it would help if the Government greatly expanded public expenditure, but the very reverse seems to be happening.

The answer to the pending economic crash, is socialism, and now should be an ideal opportunity to get this message across. Given the control of the media and the absence of sympathetic politicians, this will not be easy, but the public will be looking for real solutions and will not be fooled for ever by sticking plaster measures of Western governments. The Scottish Socialist Party offers a principled and practical solution to our economic ills and it is crucial that we get our message across.