Jeremy Warner's Outlook: Economic boon of US's sub-prime crisis

Winner's curse in battle for ABN Amro; Where are the customers' yachts?
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The Independent Online

Thank goodness for the US sub-prime mortgage crisis, which though obviously miserable for those directly affected, seems to be about the only brake there is to otherwise rip-roaring economic growth across the globe.

The monetary tightening so far applied by the Bank of England seems to be having no effect whatsoever to judge by figures published yesterday for Britain's Gross Domestic Product. Despite the squeeze on disposable incomes brought about by higher interest rates, GDP continued to grow at an annual rate of 3 per cent in the second quarter, confounding City economists who had expected the economy to slow.

The main story here was strong growth in industrial production and as yet not much sign of the expected slowdown in consumption. Again, it is our old friend China which is the driving force. Asia is sucking in capital goods at an unprecedented rate.

The main beneficiaries are those developed countries which have kept their manufacturing bases - notably Germany and Japan - but even Britain is getting something out of the boom. Jet engines and pumps, two industries where perhaps surprisingly Britain remains a world leader, are selling as never before.

China has taken over as the chief engine of world economic growth where America left off. Just think what a boom we would have on our hands if the US economy were growing strongly too. As it is, the threat posed by the sub-prime meltdown to economic health as a whole has been much exaggerated by commentators.

In Congressional testimony this week, Ben Bernanke, the chairman of the Federal Reserve, gave the chilling estimate that the crisis could end up costing between $50bn and $100bn. This is obviously an extraordinarily large sum, yet within the context of US lending as a whole it is tiny. The effect the crisis has had in dampening credit conditions more generally is in fact a positive development which has taken the froth out of financial markets previously hell-bent on excess.

It is for this reason that I say thank goodness for sub-prime, for what the crisis has done is provide a salutary lesson in the dangers of unbridled credit booms before this one had the opportunity to do real damage.

This is not to say that the benign economic conditions that have reigned for three more more years now will go on for ever. What happens when the big end of China finally goes, as eventually it is bound to? No economy in history has sustained growth of this magnitude in an uninterrupted line before, and there's no reason to believe China will break the mould. Yet interestingly, the period of adjustment the US is going through is perhaps setting the economy up to resume its traditional role of engine of world growth when China eventually stumbles.

A weak dollar is bound to have inflationary consequences for America, which means US interest rates have to stay high for rather longer than would otherwise be necessary. Yet it should also help restore savings rates and by improving the competitiveness of US industry start to address the mountainous current account deficit. In the meantime strong growth in the world economy is helping to sustain the boom in corporate profits.

All too good to be true? Well, maybe, but though it might sound counter intuitive to say it amid all the warnings of doom and destruction of recent weeks, there are still more reasons for optimism than pessimism about the present state of the world economy.

Winner's curse in battle for ABN Amro

The gladiatorial battle for control of ABN Amro may have been good for the ego of the two main British protagonists, John Varley of Barclays and Sir Fred Goodwin of Royal Bank of Scotland, but it has been no good whatsoever for their respective share prices.

The RBS share price is quite seriously down on where it was at the start of the year, while Barclays hasn't fared much better. In the case of RBS, the underperformance is not all down to its intervention in the ABN battle.

The weak dollar and the sub-prime mortgage crisis will undoubtedly be doing damage to the earnings of RBS's US operations - Citizens and Charter One. Deteriorating credit conditions in the leveraged buyout market won't have helped either. A major source of income for RBS in recent years has been the fees it earns arranging the finance for LBOs.

Yet the bigger part of the deterioration can probably be attributed to Sir Fred's return to the deal-making club. Less than a year ago, Sir Fred took a vow of self denial - no more transformational deals. Soon after, he was able to declare himself "out of the City sin bin" as the share price responded positively to the idea that Sir Fred had finally kicked the habit. Now he's back with a vengeance, and though he's not bidding for the whole of ABN, he is fronting the breakup consortium and therefore taking on all the regulatory risk of things not going according to plan. Yet perhaps strangely, the City seems less hostile to his proposal than that of Barclays. Mr Varley has been warned by a number of his shareholders not to try and match the consortium bid. Why is this? How is it that Sir Fred is allowed to get away with what is being denied to Mr Varley.

Mainly it is to do with the fact that Sir Fred is putting far less equity into the pot. The lion's share of the ABN whole is going to Banco Santander and Fortis. Sir Fred ends up with only the wholesale banking and Asian operations.

This is still a big deal for RBS, but it is not nearly as big as what Barclays proposes, where the intention is to keep all the assets other than La Salle. For Sir Fred, the ABN endeavour ultimately amounts to little more than a bolt-on acquisition. For Barclays, the deal involves hugely more equity, truly would be transformational, and therefore invites greater City scepticism.

Yet to judge by the share price reactions, the bottom line is that investors would much prefer it if neither of them were taking the plunge. This reaction is based on hard experience. Because of the bid premium, most acquisition making is far more beneficial to the acquired than the acquirer. In many cases, the deal ends up positively value destructive for the bidder. Whoever wins the battle for ABN will celebrate in having frustrated the other, yet in this clash of egos, it is perhaps the winner which needs to watch his back the more.

Barclays cannot bid more without destroying value for its own shareholders. Perhaps Sir Fred has already crossed that rubicon.

Where are the customers' yachts?

The latest tilt at J Sainsbury epitomises all that's wrong with private equity. Unions have every reason to protest, though perhaps regrettably, their calls for Government intervention will fall on deaf ears. Even if ministers could intervene, they wouldn't. The Qataris are far too important an ally, as well as supplier of energy and intelligence, to risk offending them.

Yet what is proposed is a highly dangerous endeavour which if it enriches a few is very likely to be at the expense of the many. As with all leveraged buyouts, the Qataris propose essentially to buy the company with its own money. The consequences for employment at Sainsbury and the long-term health of the business cannot help but be negative.

I don't wish to foment class warfare, but the spectacle of secretive deal-making on luxury yachts and at five-star hotels amid the Mediterranean playgrounds of the world's super rich leaves a bad taste in the mouth and is plainly offensive to the thousands of ordinary lives likely to be affected by it.

The union response may be ill-informed and knee jerk, but it is also appropriate. Where are the customers' yachts? is the title of a famous book about Wall Street based on the question asked by a visitor to the financial district on seeing all the yachts owned by the titans of the investment banking world. That book was first published in 1955. The world doesn't seem to have changed very much since then. It's just that there are even more yachts and fewer of them still belong to the real wealth creators.

j.warner@independent.co.uk

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