Private Investor: Why I'm not still laughing all the way to the bank?

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The Independent Online

Are banks a bargain? I think you can see why they might be. They've all tanked (and I'm leaving Northern Rock out of the reckoning for the moment). Even if they're off their year lows, they're pretty bruised and are well down on previous peaks. Hard as it may be to believe, but Barclays was once thought to be worth 790p a pop (against about 525p now); Alliance and Leicester was a supposed bid target at 1197p (now 600p and attracting attention again) and the Royal Bank of Scotland, complete with indigestible ABN Amro deal, stands at 422p, down from its recent high of 720p.

The best yield on offer in the sector, assuming the dividend holds up under the strain, is from the Alliance & Leicester, at almost 10 per cent. Ten per cent from a solid British bank? Even a year ago that would have been thought financial fiction. Now it is a crazy fact born of the incredible credit squeeze. Funny old world.

Of course there's reason why all these "bargains" are out there, and it is that no-one can be quite sure whether what we've heard from the banks about their declared losses are the beginning or the end of the story. I'm inclined to think we're only at the start of the banks' pain. As I've written before, the credit crunch is a process rather than an event. That means that even if the big banks have been good enough to fess up to their write-downs thus far, there could be much more to come. The reason I say that, in particular in this week, is our old friend LIBOR, which is the interest rate which banks charge each other, the market rate, over various periods, with benchmark usually taken to be the three-month rate. In all the main currencies LIBOR have spiked this week, illustrating how the credit markets are seizing-up again. The banks are "hoarding liquidity". That's a good thing because it means they're insulating their balance sheets against any nasty losses that might hit them over the next months. it's a bad thing, though, because it starts to choke credit off from the rest of the economy.

Now it's all very well for Alistair Darling and his crew at the Treasury and their counterparts in the US to go on about how strong the world's economy is; it's the future we need to be worried about. Going from a strong base isn't much comfort if it's disintegrating rapidly, which is what is happening in the States.

The real damage the credit squeeze does is in cutting off the supply of ready credit to the American sub-prime market, which you may recall, is where the trouble started.

Well, there's plenty more where that came from. The more the banks cut down on their lending to sub-prime borrowers, as they are now doing, the more chance their is that those very people will default and causes the banks more losses as they repossess their devalued real estate and dump it onto a depressed housing market for whatever it'll fetch at auction. That then rebounds on the rest of America's property market, with depressing results for the economy. That then pushes more sub-prime borrowers out of a job and into default and with no banks to turn to for help, another round of defaults and foreclosures follows. This all adds to the banks' woes as they write down more bad debts. And so on.

So that's; why it's a process, and one that feeds on itself. In fact, it's a fairly common phenomenon in economies think of the Keynesian income multiplier (or look it up on Google).

So banks such as Barclays, Alliance & Leicester and Royal Bank for Scotland (let alone Northern Rock) can be wildly overvalued even at current levels; I believe they are and would advise everyone to avoid them.

What small, spare funds I have will be ploughed into a distressed sector of the market that contains a couple of gems. Commercial property firms and REITS haven't fallen sufficiently to tempt me yet, though I'm confident they will. My money is going into Savills and Rightmove, which are two excellent secular stories. Savills has seen some very heavy selling lately, but I would put its wealth management capacity and its Hong Kong exposure against its top-end UK business, which admittedly will be hit by the decline in City bonuses this year.

Rightmove is just a very good website that will benefit from the migration of advertising to the Web. It might even do well in a housing slump of volumes go up. A silver lining...

s.ogrady@independent.co.uk

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