It doesn't seem to be getting any better for America's beleaguered banks, with both Citigroup and Merrill Lynch yesterday announcing fresh injections of capital from the Middle East and Asia to shore up balance sheets damaged by the meltdown in mortgage-backed securities.
The result was another round of carnage in global equity markets, which are beginning to wonder whether bankers are ever going to be able to draw a line under the crisis in their affairs.
With losses from sub-prime still mounting, this is the second recapitalisation that both Citi and Merrill's have been forced to launch. The terms are just as onerous as first time around, with the coupon on the Citi convertible set at a humiliating 9 per cent. So too is the nature of the investors. Over the past three months, Citi, Merrill and Morgan Stanley combined have gobbled up nearly $40bn of new equity from Middle Eastern and Asian sources. There could scarcely be a more graphic illustration of who now calls the shots in global capital markets.
New chief executives like to "kitchen sink" their accounts when they move into the job in the hope of establishing a new base level from which to rebuild. Yet Vikram Pandit, the new man in the hot seat at Citi, was wholly unconvincing during his conference call yesterday in attempting to reassure that this was indeed the end of the matter. Analysts were left struggling to figure out for themselves the degree of write-down taken on assets, making it impossible to know whether Citi's remaining $30bn exposure to mortgage-backed securities may have to be further impaired.
What is the read across from this dire state of affairs to the UK banks? Despite its crippling effect on credit markets worldwide, the sub-prime meltdown is primarily an American affair. Direct British exposure to the CDOs and other mortgage-backed securities that have been doing all the damage, though significant, is proportionately not nearly as big as the likes of Citi and Merrill's.
Even so, the capital position of Britain's major banks is in some respects a great deal worse. Leverage among UK banks – that is the multiple of lending over deposits – has increased very substantially in recent years as credit markets boomed, and by US standards, some are beginning to look critically undercapitalised.
Again unlike the US, where there is a longer tradition of focusing on which banks have the superior capital ratios, investors in British banks have tended to ignore or discount the capital position. In the good times, it seems unimportant how well capitalised a bank is. It's only when conditions get rough that it becomes an issue.
The most capital-constrained of the big British banks is Royal Bank of Scotland, where tier one equity capital is just 4 per cent. Together with tier two capital, Royal Bank is still comfortably above the minimum demanded by regulators. Even so, it is now a long way below what many peers in the US and Europe enjoy, particularly after the just announced round of capital injections by Citi and Merrill's.
The best guess is still that RBS and other major British banks will somehow manage to muddle through, without need for an emergency rights issue or cash-raising exercise from Middle Eastern and Asian sovereign wealth funds, but even with asset disposals, it's touch and go. Don't be surprised by news that "bin" someone or other previously unheard of has just become RBS's biggest shareholder.
Howard's way of regulating markets
Sir Howard Davies, former chairman of the Financial Services Authority and now director of the London School of Economics, was in characteristically articulate form last night in lecturing the Oxford Institute for Economic Policy on the future of financial regulation.
You'll be pleased to know (or maybe not, depending on your point of view) that he doesn't believe the credit crisis presages the end of capitalism as we know it, but that he does none the less think it provides a vivid demonstration of the importance of robust regulation for the capital markets. He also doesn't want to hear any more loose talk about "light touch regulation", which when he was lying on "the FSA's bed of nails" only made life harder in the pursuit of adequate supervision.
So far, so unsurprising for a former regulator. Also rather unsurprising was his defence of the much-criticised Tripartite arrangements under which the Bank of England, the FSA and the Treasury are meant to come together to deal with financial crises: he was, after all, one of the Tripartite structure's authors. In Sir Howard's view, if there was regulatory failure, it was more to do with errors in judgement than structure.
Ignoring his bias, Sir Howard may well be right about this. There is no reason to believe the Northern Rock debacle would have been handled any better had the Bank of England still been in charge of supervision. There were good reasons for splitting these functions from responsibility for monetary policy, most of which still hold good.
Rather more open to question is the narrowness of the Bank of England's remit, with its heavy focus on inflation targeting to the exclusion of virtually all else, and whether this helped both to foment the crisis and made the Bank slow to recognise its gravity.
Low interest rates made possible by internationally low levels of inflation helped to create the explosion in credit and asset prices that lie at the heart of the present crisis. The Bank of England repeatedly commented on the mispricing of risk that was taking place in credit markets but did nothing about it, arguably because it had no overt responsibility for doing so. With the Bank's best brains focused almost exclusively on inflation, financial stability became an afterthought.
In the lead-up to the Northern Rock debacle, there was also subsequently reported conflict between the Bank of England and the FSA as to whether the banking system as a whole should be supported with injections of liquidity. The Bank, which controls the levers by which this liquidity can be added, is said repeatedly to have ignored the FSA's pleas for action, apparently oblivious to the seriousness of the crisis.
So I'm not sure the system works quite as well as Sir Howard suggests. Policymakers everywhere will be examining whether narrow, inflation-targeting remits such as the one pursued by the Bank of England are actually the whole answer. The past six months suggest strongly that they are not.
Where Sir Howard is undoubtedly right, however, is in arguing that "it is always dangerous to devise regulatory policy in the midst of a crisis". As he has said before, financial regulation is best explained by a series of Dangerous Dog Acts, with wrongheaded regulation often conceived in haste in response to the latest example of excess and repented at leisure as the law of unintended consequences asserts itself.
Public finance rules lose their credibility
All of Northern Rock's £100bn of liabilities will have to be recognised on the Government's books if the mortgage bank is nationalised, provoking for the first time a breach in the "sustainable investment rule". This stipulates that public debt must remain at or below 40 per cent of GDP.
Ministers will insist that since public ownership of the Rock is intended to be "temporary" and that the liabilities are in any case matched by assets, the breach is largely a technicality which shouldn't have any effect on fiscal policy. Yet it is also another nail in the coffin of the fiscal rules Gordon Brown put in place when he first became Chancellor. A constant shifting of the goal posts and massaging of the figures has already made the separate but linked "golden rule" almost wholly meaningless. The Treasury must urgently replace these rules with independently monitored alternatives to re-establish credibility with markets in the way it manages the public finances.Reuse content