A semblance of calm returned to credit markets yesterday, with continued support from the US Federal Reserve and news of a $2bn bailout by Bank of America of Countrywide Financial, the largest US mortgage lender. Does this mean that the crisis is now essentially over? A major financial institution may still need to go bust before the air is cleared.
Financial crises can be compared to the spectacle of a massive meteorite hurtling towards Earth with the prospect of untold destruction once it collides. Understandably, everyone panics. Yet the zenith of the panic occurs not at the point of collision but in the anticipation of collision, and then vanishes the moment it is realised the meteorite is actually not going to collide at all, but will miss the Earth by a hair's breadth.
The continuing problem with the present crisis is that nobody yet has a handle on the size of the losses or where they might lie. Until these things become clearer, markets will continue to assume the worst and act accordingly. We just don't yet know how bad it is. This uncertainty has caused trust between counterparties to breakdown, making credit more expensive and harder to obtain. This in turn is bound to extract a price in the real economy.
Even so, the best bet remains that it is probably not as bad as it seems. The sub-prime mortgage sector where the crisis began is a comparatively minor part of US lending as a whole, and even here nobody is going to lose absolutely everything. Even in Detroit, real estate is still worth something. The same goes for most other high-risk debt securities.
In some hedge funds, the losses being sustained on these securities will have become magnified by leverage. For instance, in a fully invested fund which is 90 per cent geared, it only requires the underlying securities to fall by 10 per cent in value to wipe out the entire equity of the fund.
As banks act to reduce their exposure to this leverage, trading positions have to be liquidated to pay down the debt, causing a downward spiral in the value of the securities. This process is not yet fully worked out. It may still be some months before banks are able to give a clear idea of the haircut they have been forced to take.
By way of example, take Royal Bank of Scotland. RBS is a big player in the corporate debt markets and in current conditions will undoubtedly have been unable to refinance some of the loans it has taken on to fund the recent mergers and acquisitions boom. Does the bank take an immediate write-off on these debts, or does it just sit on them until conditions improve? At the very least, profits will be hit by a sharp reduction in the fees RBS earns for providing the finance. These have been a major source of revenue to the bank in recent years.
Returning to the metaphor of the meteorite, we are still not at that point of realisation where we know for sure whether it is going to hit or miss. Until we get there, conditions are likely to remain highly volatile.
Common sense rules in SME banking
In recent months, there's been an unexpected outbreak of common sense among competition regulators about the "big, bad" high-street banks. First the Office of Fair Trading (OFT) held off from declaring allegedly excessive overdraft charges to be outright illegal, agreeing instead the issue should be decided in a test case by the courts. Now the Competition Commission, advised by the OFT, has provisionally agreed to remove price controls on what the "Big Four" charge small and medium-sized enterprises (SMEs) for their services.
These controls, imposed in 2003 after a Competition Commission investigation of the sector, were always a nonsense, more likely to diminish competition than improve it. Now the Competition Commission has conceded that the costs of compliance exceed any likely benefit. The commission's deputy chairman, Christopher Clarke, insists they were always intended to be temporary. What's more, he says, there is now evidence of other significant banks such as HBOS, Abbey and Alliance & Leicester competing more strongly for this business.
This latter claim, it ought to be said, is barely supported by the evidence. Since the controls were imposed, the market share of the Big Four - Royal Bank of Scotland, Barclays, Lloyds TSB and HSBC - in the SME market has shrunk by an only marginally significant 7 percentage points to 85 per cent. The amount of switching by small business customers between banks - perhaps the best gauge of whether competition is working - has actually gone down.
The reason for this is obvious if you think about it. If you cap what incumbents can charge their customers, you increase barriers to entry, making it more difficult for worthwhile competition to develop. Paradoxically, competition grows more rapidly if charges are high, as this gives newcomers an incentive to attack the market. To be fair on the regulators, other measures introduced at the same time such as improved transparency and easier switching mechanisms do seem to have helped, and these are being retained.
Yet the bottom line about the British banking sector is that it is well capitalised, relatively good value by international standards, works smoothly, provides virtually boundless credit for worthwhile ventures, and in the round serves its customers well. The number of satisfied SMEs far outnumbers the discontents, and, in the vast majority of these latter cases, the fault lies with the business itself.
Photo-Me boss finally faces the chop
Is it game over for Serge Crasnianski, chief executive of Photo-Me International (PMI)? He's been a corporate governance nightmare from the moment he first surfaced on the UK scene in the early 1990s. Long before Mike Ashley of Sports Direct came along to claim the title of most mistrusted man in the City, Mr Crasnianski was already a serial offender of impressive form.
Excusing his action some years ago in flogging off a large part of his personal shareholding shortly before the company issued a calamitous profits warning, he said he could hardly be judged to have had inside information because obviously he would have sold the lot had he realised the stock was about to collapse. This at least had the merit of being quite funny, but it hardly endeared him to the fund managers who had just been stuffed with his shares.
That this former nuclear scientist remains in situ at all is explained by the fact that he still owns nearly 20 per cent of the company, and, perhaps more important, personally lays claim to the patents on much of the technology that goes into PMI's photo booths. Without him, there arguably wouldn't be a company at all. Even so, outside shareholders have for years been trying to get rid of him and the cronies with whom he has packed the board.
The last year has seen progress, with agreement for board changes and the launch of a strategic review. But the pace has been glacial, and now outside shareholders led by Brian Myerson's active investment fund, Principle Capital, have lost patience and requisitioned an extraordinary general meeting to remove Mr Crasnianski and his chairman, Vernon Sankey. They also want to see the proposed auction of the company's main asset - its photo booth and kiddies rides business - halted, arguing that the operation has been so incompetently managed that it would realise only a fraction of its real worth if it is sold now.
Photo-Me asks the activists to hold off until they see what the auction yields. Mr Crasnianski will be retiring shortly in any case, the company insists. Too late. Principle does not intend to withdraw its demands. With supporters, the activists claim to speak for 46.3 per cent of the stock, which on a vote would be enough to get what they want. Mr Crasnianski may be mistrusted in the City, but within the company he is liked and still commands support. Nonetheless, it is hard to see how even the Houdini-like Mr Crasnianski can wriggle out of this one.Reuse content