Jeremy Warner's Outlook: Crisis set to deepen before it gets better

A small ray of hope at Northern Rock; LSE faces onslaught of new competition; M&S stumbles in satisfaction index
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With spreads on overnight and term money now back virtually to normal, is the credit crisis over? Regrettably, that's unlikely to be the case. The reason Libor is again at close to bank rate – though actually the spread rose a bit yesterday – is not because the system is functioning normally once more, but rather because central bankers have flooded it with liquidity in a manner which has temporarily bailed out large parts of the banking system.

The appearance of normality is largely illusion, and in the absence of repeated central banking bail-outs, further stresses are likely to assert themselves in the months ahead. This is more so as many banks and corporations have determined to use the present lull in the credit crisis to address the mounting weight of redemptions. A consequent flood of new issues is expected as bankers and companies rush to refinance overdue loans.

Wall Street is again rife with rumours of further big write-offs to come, and it may be that a number of major banks, both in the US and Europe, will be forced to seek yet more injections of emergency capital. In other words, we may not yet have seen the worst of the banking crisis. Rock bottom (forgive the pun) is still to come.

Some banks are said still to be in a state of denial about the extent of their losses. There is a marked reluctance to mark-to-market in the manner demanded, with some bankers continuing to take the view that they can ride out the storm without needing to recognise bad debts on the scale which market prices dictate. The reality is that the sooner these losses are purged, the faster the banking system can be set on the road to recovery.

If they are left to fester on the books, they only support uneconomic activity and deprive newer forms of wealth creation of access to capital. As in Japan in the 1990s, there is a real danger of economic paralysis in unrecognised bad debt. In order to move on, the banking system needs first to take it on the chin.

A small ray of hope at Northern Rock

As the Northern Rock debacle draws towards its final denouement, certainty of outcome remains as illusive as ever. For shareholders, there was a small ray of hope yesterday amid all the predictions of inevitable nationalisation to come with news that the Rock has managed to sell its life-time mortgage portfolio to JP Morgan for £2.2bn.

Admittedly, this represents just 2 per cent of the company's total lending book, and will knock but a small hole in the £27bn it owes through the Bank of England to the Treasury. Yet it is at least something, and what is more, the fact that the sale has taken place at above book value gives some reason to believe that that the rest of the business could, as the company's two largest shareholders insist, be valued on a similar basis.

Unfortunately, nobody seems to be rushing either to buy or finance the rest. Goldman Sachs is working on proposals to pay back the Government by securitising its Northern Rock loans through the issue of bonds. Yet such an approach might require the Government's continued involvement, with the Government in effect underwriting the bonds. Also unclear is how much ongoing profit the company would be left with if its book were further securitised.

Alistair Darling, the Chancellor, has promised to resolve the situation one way or the other shortly. He's still desperate to avoid nationalisation, which would amount to an admission of almost total regulatory failure as well as sending out all the wrong signals to the markets on the Government's propensity to indulge in bail-outs.

But he's under plenty of political pressure to do so. Personally, I can't see the point of it. The idea that nationalisation would somehow bring closure on the affair is naive. To the contrary, I suspect that this would be just the beginning of the Government's problems with this unwanted mortgage book rather than the end. Yet the private sector does need to get a move on in finding an alternative solution.

LSE faces onslaught of new competition

The London Stock Exchange's apparent attractions as an investment, with Middle Eastern borses jostling for control, are not mirrored in the satisfaction of its customers, or at least not some of the larger ones. The big investment banks are so fed up with the quality of service and the fees charged that they are setting up their own rival trading platform, which they confidently expect to be able to offer a better service at a fraction of the price.

When Project Turquoise, as the endeavour is known, was first announced a year and a bit ago, it was widely thought to be just sabre-rattling by big users determined to force a reduction in charges but unlikely to have the resolve, cohesion or backing to actually set something up. As soon as the LSE responded, the threat would go away.

Well, the LSE did respond with a reduction in charges but the investment banks are not backing off. As effective monopolies of their own domestic markets, European exchanges are accused of fleecing their customers to line the pockets of their investors – a practice, by the way, that investment banks are more familiar with than they care to admit. With no prospect of price regulation in sight, the investment bankers are determined to introduce some decent competition to drive down prices instead.

The enterprise already looks more than credible. There are offices and staff, a chief executive, a technology platform (Cinnober of Sweden), and a clearing house. Project Turquoise is close to signing up DTCC, the main clearer for securities in the US, to do the clearing function. Investment banks expect the platform to be up and running by August, with prices between 50 and 75 per cent cheaper than the LSE, including clearing.

How much of a threat to the LSE do these plans pose? Turquoise's backers expect the new market to take around 10 per cent of the market almost immediately, but aspire to 30 per cent, with 20 per cent after two years.

The key issue for the LSE is how much of this slice of business will be new volume, and how much carved out of current volumes. There is good reason to believe that most will be new. In the US, volumes are proportionately twice as high as they are in Europe, a characteristic which investment bankers attribute almost entirely to lower charges.

The LSE's critics believe that a quite small reduction in charges would have an exponential effect on volumes, as heavier volumes are likely to encourage investors to trade in bigger chunks. As things stand, the system conspires to make investors split big orders into smaller packages in a manner which maximises charges for the exchange.

Even if Project Turquoise is all new volume, then, it is quite likely to have a quite significant effect on the LSE by driving charges down much more rapidly than would have occurred otherwise. Clara Furse, the LSE's chief executive, has another challenging year ahead of her, only this time it will be in fighting off the competition rather than the potential bidders.

M&S stumbles in satisfaction index

No surprise in finding John Lewis at the top of Verdict Research's survey of Consumer Satisfaction among major retailing companies. More surprising was Marks & Spencer's complete absence from the top 10 and even more so was its failure to make the top three for clothing, having been outgunned by John Lewis, H&M and Asda.

Indeed the only category where it figured at all was footwear, and even there it was beaten into third place by TK Maxx and Asda. This is not good news for a company that bills itself as the Tesco of clothing retailers and lends some weight to the idea that this week's poor trading update was about more than just the slowing consumer economy.