Jeremy Warner's Outlook: Fed in danger of overreacting to crisis

HSBC activists: good case but too late; BSkyB: too much regulatory risk?
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The Independent Online

Alan Greenspan is right to draw parallels between the present credit crunch and the financial crisis of 1998, when as chairman of the Federal Reserve he was forced to organise a rescue of the distressed hedge fund, Long Term Capital Management.

The two crises are quite similar in their constructs, even if there are also key differences. In 1998, sovereign debt defaults in Russia caused bond prices to fall unexpectedly, which in turn made it hard for LTCM and others to borrow and threatened to prompt a fire sale of assets. Something similar is happening this time around, only the defaults are not in Russia, but the US sub-prime mortgage market.

It looks as if the policy response is going to be similar too. The credit crunch had already made the chances of an interest rate cut at the next meeting of the Federal Reserve's Open Markets Committee on 18 September close to a racing certainty.

The book on the decision will have been closed entirely after yesterday's US labour market figures, which showed that even before the crisis in debt markets kicked in, US employers were already cutting jobs, the first such contraction in employment in four years.

Wall Street had expected the monthly figures to show hirings still in expansionist mode, so there was blind panic as the cry went up that America is slipping into recession. Stock markets reacted accordingly. It is a complete mystery to me why a cut of just 4,000 jobs, which is what the labour figures for August showed, in a non-farm workforce as large as that of the US should presage a recession, yet the markets don't need much to unnerve them these days.

The way things are going, recession will soon become a self fulling prophecy. The more investors and consumers think there is going to be a recession, the more likely it becomes. Again there are parallels with both 1998 and the stock market crash of 1987 here, when there was a similarly determined attempt to talk the economy into recession.

In these circumstances, Ben Bernanke, the Fed's still newish current chairman, may feel he's got no option but to cut rates sharply in the months ahead. Some are already talking of a full half-point cut at the 18 September meeting. This is what happened after the stock market crash of 1987 and again after the financial crisis of 1998.

On both occasions, the Fed's actions arguably prevented the economy from going into recession. But they may also have only delayed the inevitable and by feeding the latter stages of the boom, made the eventual outcome that much worse. After 1987 came an even more intense debt-fuelled consumer and leveraged buy-out boom which eventually collapsed in exhaustion into the recession of the early 1990s. After 1998 came the dot.com madness of the technology bubble and the eventual US recession of late 2001.

On this rule of thumb, action by central bankers now may avert recession in the short term only for it to kick in more seriously two to three years later. In drawing parallels with 1998 and 1987, Mr Greenspan expressed the view that there is not a lot that can be done about the human propensity to create bubbles. His own not inconsiderable role in the process somehow got left out of the script.

HSBC activists: good case but too late

Less than a year ago, Stephen Green, executive chairman of HSBC, was accused by one City fund manager in an unguarded moment of being "asleep at the wheel", but I fear that it is the US activist investor Eric Knight who seems to have dozed off now. Hadn't he noticed there is a banking crisis going on?

This would seem to make the timing of Mr Knight's demands for changes in strategy and governance at HSBC peculiarly inappropriate. It also makes some of his implied criticisms of HSBC as too big and diversified look a little wide of the mark. In a crisis, these characteristics become a positive boon, which is why HSBC shares have weathered the turmoil rather better than many of the bank's peers over the past two months. Even so, some of Mr Knight's criticisms will resonate with other shareholders. Over the years, HSBC has significantly lagged peers in both its return on capital and its share price performance. There is a suspicion that size has been pursued for the sake of it. Five years ago it was fashionable to argue that only those with truly global reach could hope to prosper.

Of the British banks, only HSBC seemed to have it. Yet despite what by Knight Vinke's estimate is £40bn worth of acquisitions over the past 12 years, there's not much evidence of the revenue and cost synergies that were meant to flow from this global approach to banking. Many of the banks acquired are run at arms length as standalone enterprises.

A case in point may be HSBC's £3.1bn acquisition of a 51 per cent stake in Korean Exchange Bank earlier this week. As Knight Vinke's investment director, Glen Suarez, points out, if HSBC shareholders had wanted to buy into KEB, they could have done so directly, and they wouldn't have had to pay the premium HSBC is forking out. HSBC may be global, but it is also quite thinly spread. It has got a foot in virtually every market in the world, yet in only one of them, Hong Kong, is it among the top three players in any of the banking operations it operates in.

As I say, all these seem to be perfectly valid criticisms. Yet in the main, they are also a little out of date. Had Mr Knight made all these points a year ago, he would have hit the nail on the head and would no doubt have gathered quite a bit of support in his call to arms among other shareholders.

Yet having been hit badly and relatively early by the subprime crisis in the US, HSBC has already been shaken out of any previous complacency. Action has been taken to address these problems, and the company has already explicitly shifted direction by indicating that he plans to focus future expansion on emerging markets and insurance.

Mr Knight is calling on Simon Robertson, the City veteran appointed in the immediate aftermath of the subprime debacle as an independent non executive director, to conduct a review of strategy, remuneration and governance. Yet he is already part of a board which has and continues extensively to review strategy. To agree to what Mr Knight is demanding would be a vote of no confidence in Stephen Green, the executive chairman, and thereby put him in an untenable position.

Many of the acquisitions of recent years were with the benefit of hindsight probably not as well thought through as they should have been. The purchase of Household – pushed through in his pomp by Mr Green's predecessor, Sir John Bond – was particularly ill considered. Yet there wouldn't be much point in selling it now. With its heavy exposure to US subprime lending, HSBC would virtually have to pay for someone to take it off its hands.

Mr Knight makes some good points, but he's too late, and it seems doubtful he'll make headway with other investors.

BSkyB: too much regulatory risk?

Dresdner Kleinwort has put out a "sell" recommendation on BSkyB, arguing that the pay-TV group faces growing regulatory risk. In particular, the investment bank reckons that Ofcom in its current review of the pay-TV market is likely to conclude that competition is not "working effectively" and therefore refer Sky to the Competition Commission.

If the CC agrees, it could impose a number of remedies, including in extremis an enforced separation of content ownership from retail distribution. Even the lesser penalty of a wholesale supply obligation on premium channels at a regulated price might prove painful. Yet if it happens, it is quite a long way off, and in any case Sky seems to be positioning itself well with its expansion into broadband and telephony to protect itself against these threats. The recent history of companies that establish a dominant position in new markets and technologies – think Microsoft – is that in practice the regulatory onslaught is not in the end as damaging as it might have been. Kleinwort identifies a potent threat, but it is probably a containable one.

j.warner@independent.co.uk

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