Jeremy Warner's Outlook: Bargain hunters return to mortgage-backed securities, so is the credit crisis now over?
King and the City make odd bedfellows; Another bold bet from BG Group
Thursday 01 May 2008
Just as markets always overshoot on the upside, they also have a tendency to over-correct on the downswing. Have we already reached that phase with the credit crisis? That's long been the view among bankers, and now there's some support for it from the Bank of England's latest Financial Stability Report.
The Bank points out what has been apparent for some while now – that there is a severe mismatch between the poleaxed market value of most mortgage-backed securities and their likely value at maturity. For the depressed market value of these securities to be justified would require a level of credit default considerably higher than present run rates in the US, or indeed anything bankers think remotely possible.
One of the lessons we have been forced to learn from the banking crisis is always expect the extremely unlikely. Obviously, if there was a depression, present prices might indeed be justified. Yet even on the assumption of a relatively prolonged recession, most mortgage-backed securities now seem mispriced, a phenomenon which is attracting bargain hunters. By the way, don't bother trying if you are a retail investor. The spoils of this particular bargain-basement clearout are only available to the big boys. As a retail investor, it is almost impossible to lay your hands on the stuff. The City wins again.
Despite the fact that many mortgage-backed securities will eventually pay back in full, or in any case somewhere close, modern accounting rules force banks to "mark to market". Announcing its right issue this week, HBOS was forced to write down its holding of mortgage-backed securities by £2.9bn, even though it believes that on maturity it will eventually get all its money back.
The effect of these impairment charges is to make banks seem undercapitalised, and thereby contribute to the pressure for rights issues. Once the workout is complete, then, we may end up with the bizarre spectacle of banks writing it all back and thereby seeming acutely over-capitalised. The party could begin all over again.
Well, perhaps not quite. Bank-ers have just received the shock of their lives, and it seems unlikely they will again allow traditional standards of risk assessment to be thrown to the winds with such abandon any time soon. A few green shoots seem to be poking up through the frozen soil of the credit crisis, but it is still too early to declare spring has sprung, let alone the return of summer.
King and the City make odd bedfellows
The Governor of the Bank of England, Mervyn King, is no doubt right to highlight the role played by excessive City pay in the credit crisis, and in particular the manner in which it incentivises extreme risk-taking by bankers and traders. He is also right to lament the lure of the City to the young and talented, to the detriment of other, perhaps more deserving, but less well-paid industries.
While he was about it, he might too have criticised the commanding position enjoyed by the City under Labour in dictating public policy, but didn't, possibly because it would have been too close to the bone. No other industry has been treated as favourably as financial services, which the way ministers dance to the City's tune sometimes seems like the only business that matters in Britain any longer. The Government has leant over backwards to champion its interests.
Mr King, on the other hand, looks back to the grand traditions of the Victorian age in thinking that the people that matter are not the silver-tongued money men of the City, but the horny- handed men of toil who beaver away unthanked and unloved in the manufacturing industries of the Midlands and the north.
Sometimes the Governor looks more Labour than the Prime Minister. Certainly he seems to have a better feel for the gallery of public opinion. Even the fiercely populist Vince Cable struggles to emulate Mr King's compellingly lucid analysis of the mess we are in.
Yet if you are going to claim the moral high ground on City pay, it doesn't exactly help your case if you are quite highly paid yourself. Mr King was paid nearly £300,000 last year. He also enjoys exceptionally generous pension benefits as well as a standard of grace-and-favour personal service which owes more to Britain's imperial past than the modern world.
Mr King is not well paid by City standards, but against his peers he very much is. Ben Bernanke, the chairman of the US Federal Reserve, earns less than half Mr King's salary, while Jean-Claude Trichet, the president of the European Central Bank, is on markedly less. Both these men, it is unkindly said in the City, have done a rather better job in defusing the credit crisis than Mr King.
None of this invalidates Mr King's point, yet it does highlight one of the abiding themes of the Bank of England's handling of the credit crunch. The Governor plainly doesn't like the City very much. It is always going to be difficult to command authority among those you despise. Mr King is not expected to act as a cheerleader for bankers, but, because of finance's ability to wreak havoc on the wider economy, he does need to be sensitive, even sympathetic, to its needs.
Until recently, the Governor adopted the reverse position in believing the City ought to be punished for the folly of its ways. It may be very satisfactory to see bankers get their comeuppance – a bit like the pleasure we all derive from seeing a Rolls-Royce wheel clamped – but nobody will thank the Bank of England for being an avenging angel if it plunges us all into a recession.
As it happens, the Governor's relationship with the major banks has got much better since the Northern Rock debacle. Whereas before there was hardly any contact, there's now lots of it. The Governor is not entirely to blame for his previous isolationism, which started when responsibility for banking supervision was removed from the Bank of England and placed with the Financial Services Authority.
Mr King has been forced to learn the hard way that when the City gets sick, it doesn't matter what the legislation or the economic textbooks on moral hazard say, the central bank has no option but to treat the illness until the fever goes away.
Another bold bet from BG Group
Frank Chapman has done such an impressive job in making BG Group into one of the darlings of the stock market that nobody would dare challenge his judgement in making a £6.1bn bid for Origin Energy, Australia's second biggest energy retailer.
All the same, there's been so much momentum in the BG share price that analysts were beginning to think the next stop would be £20 or more. Even for a company of BG's size, £6.1bn in cash is a big bite which will take some time to digest, and therefore puts a quite severe brake on medium-term prospects for the share price. What with exciting discoveries in Brazil and elsewhere, the betting was that BG would eventually become a target for the Chinese, or perhaps even one of the reserves-starved oil majors.
Now it looks as if Mr Chapman is intent on becoming a major himself, a not implausible long-term ambition but one that might undermine the easy short-term gains for investors.
BG is not, of course, primarily interested in Origin's retail business, an Australian version of Centrica, the UK energy group which BG was once united with under the ownership of British Gas. The retail arm is likely to be sold on the successful acquisition of Origin. Rather it is the company's interests in so-called "coal seam gas" which are the attraction.
BG is already an operator in this market through a joint venture with Queensland Gas Company in Australia. BG thinks that eventually these assets will become a major feed source for the group's fast-growing liquefied natural gas interests. In an increasingly energy-scarce world, Mr Chapman reckons that LNG is one of the best places to be. All his bets have proved right so far. Here's hoping his winning streak is not about to run out.
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