Jeremy Warner's Outlook: Stigma threat causes Bank auction to flop

Click to follow
The Independent Online

If there was any remaining doubt over the need to reform the Bank of England's lender of last resort and open market functions, it was laid to rest yesterday by news that the Bank's auction of £10bn of term money had failed to attract a single bidder.

This was an entirely predictable outcome brought about by a combination of two factors. One is that credit conditions in the interbank market are beginning to ease of their own accord. There is no point in borrowing from the Bank at a penalty rate of interest when it is cheaper to borrow in the market from someone else.

Yet the more important reason is that following the terrible example of what happened to Northern Rock, nobody dares avail themselves of facilities that have the potential to stigmatise them and make everyone think that if they are borrowing from the Bank then they must be in trouble. The framework for support has thus come to be seen as likely to provoke the very crisis it is designed to prevent. If the Bank of England's armoury of credit support facilities was the Monty Python parrot, it has never looked more dead.

As I understand it, a half-hearted attempt was made to persuade big, highly solvent banks publicly to use the facility in an effort to remove the stigmatising effect. This might have allowed the genuinely needy to borrow under cover of the bigger fry. A similar ploy seemed to work quite well in the US a few weeks back.

Perhaps unfortunately, altruism is not a characteristic in strong supply in today's highly charged capital markets. The attitude of the big London banks was that they weren't going to borrow at a penalty rate just for the sake of doing the Bank of England a favour in its efforts to provide wider support to the banking system. More evidence, then, of the framework breaking down.

The Bank really has got itself into a frightful mess in its determination to defend the principles of moral hazard. This in itself is a noble cause, but the true leader also has to know when to compromise. In this regard, the Bank has repeatedly failed. True enough, it did ease the rules on the collateral that could be pledged against the emergency funding, but it refused to budge on the interest rate, which continues to be set at a penalty level above base rate.

An attempt was made to persuade the Bank to switch tack and, like the European Central Bank, lend at market rates. The Bank refused. This, in turn, has made lending eventually at market rates – so the truly needy can borrow without fear of stigma – all but impossible. If the Bank now begins to lend at a non-penalty rate, everyone will think something really nasty must have happened to make Mervyn King, the previously intransigent Bank governor, change his mind. Again, the effect would be to exaggerate the sense of crisis, rather than defuse it.

All that said, markets may be starting to come to the Bank's rescue. The indications are that the crisis that has gripped credit markets this past two months is beginning to ease. That doesn't mean there won't be another lurch downwards before money markets return fully to normality. There might well be.

Nor does it mean a return to conditions that presided before the crisis hit. Credit risk has been widely reassessed and repriced on a likely permanent basis, or at least until the next time. The Bank of England's new quarterly survey of credit conditions has warned that one consequence of the turbulence is that the cost of corporate credit may rise. It may also become more restricted.

Curiously, the survey found that household lending would be largely unaffected. Can it really be that a crisis prompted by the meltdown in US sub-prime lending will have no affect whatsoever on British consumer and mortgage borrowing, but will affect lending for business investment? This seems to me a somewhat incredible conclusion, but we'll see.

In all other respects, the signs are encouraging. Earlier this week, Bradford & Bingley, widely thought one of the most exposed British mortgage lenders after Northern Rock, managed to sell £500m of two-year covered bonds, apparently without difficulty. B&B has also been active in buying back its own shares. These are not the actions of a bank about to go under. Likewise, bankers to KKR have finally managed to sell on a large slug of the debt associated with the private equity buyout of First Data. Admittedly, they have been forced to settle for 96 cents in the dollar, but it's progress all the same.

As the credit crunch hit, bankers preferred to shut up shop completely rather than lend against collateral whose risks they didn't understand. A separate, more rapacious, motive was that, by refusing to buy, they would drive asset prices down to a level where they could eventually expect to pick up bargains.

Both these influences are waning. Pricing power is returning as credit risk becomes better understood and calibrated. Bargains for bankers may also only be at the cost of a haircut for valued clients. Bankers have begun to realise that this might not be such a great money making idea.

So are we witnessing a repeat performance of 1998, when a similar credit crunch, prompting panic among bankers and dire warnings of global recession, quickly went away as soon as central bankers had acted? I'm beginning to think we might be. On that occasion, it was ultimately only pain delayed. The real downturn set in a couple of years later. Mr King has warned of the dangers of sowing the seeds for future crises by acting to ease the self-induced distress of markets. Let's see how it all pans out.

Bowman heads for the hat-trick

Philip Bowman is something of a hero among City investors. Over the past three years he's managed to sell two FTSE 100 companies at eye-watering prices. Can he make it a hat-trick with Smith Group now that he's replacing Keith Butler-Wheelhouse as chief executive? Well, possibly (the shares surged yesterday on hopes that he can), but it may be an altogether tougher ask than with Allied Domecq and Scottish Power.

What would once have been the most likely bidder, GE of the US, has already bought the bits of Smith it really wanted – the aerospace interests – while the separate joint venture with GE on airport scanners was abandoned acrimoniously last week. There's little reason why GE would want to return for the rest. Meanwhile, private equity is presumably out of the game, at least for the time being, and in any case, Mr Bowman insists that he is no "breaker-upper". He's come in to improve the business, not to break it up and sell it off. Improving the business is what he did with both Allied Domecq and to a lesser extent Scottish Power, where he wasn't long in the job, before eventually selling them. It was only after he'd spruced up properties which had previously been in a state of some disrepair that he was able to realise their full value.

The first task, then, is to grip the company and improve the performance. It was somehow symbolic of the legacy problems that Smith still has to deal with that the company was yesterday forced to provide another £101m for the legal costs of defending ancient asbestos-related litigation.

Having already sold two FTSE 100 companies for excellent prices, Mr Bowman must already have made his pile, so why does he want to do it all over again? The answer he would give is that of Edmund Hillary: because it's there. He's also had a long association with Donald Brydon, the Smith Group chairman.

Mr Brydon was with him as a non-executive director at both Allied Domecq and Scottish Power. Mr Brydon, by the way, has his own track record as a seller of FTSE 100 companies to defend. A former fund manager, he was chairman of Amersham when it was sold a few years back to GE, again for a fabulous price.

On one thing shareholders can be certain. It may take time for the right offer to come along, but when it does, the new team at Smith Group won't be sentimental in agreeing it. Just don't expect imminent action, that's all.