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For BoE read MBIA
Jan. 17th, 2009 02:50 pmApparently the Treasury is getting fed up with injecting capital into banks, only for the banks to say "well, we can't lend any of this out to customers; sorry". Meanwhile Sunny Gordon appears to have taken leave of his senses in this morning's FT, where he urges banks to "come clean" on how much toxic debt they have on their books. Perhaps, in a Brownite way, he is hinting that Barclays is quite clearly being a fraction (well, ok, "very") optimistic in its calculations on the integrity of some of its debtors. But that is not the same as failing to say exactly how much the toxic debt is worth; because, as is perfectly plain, not knowing what the toxic debt is ultimately going to be worth is what caused banks to stop lending to each other in the first place.
And then, in a move which seems to make a nonsense of Brown's urging anyway (discord between the BoE, the Treasury and the prime minister? Heaven forbid) the new wheeze is to turn the Bank of England into a new version of Ambac, or MBIA.
So, let's step back a bit and see roughly how this mess started, because it's all the fault of the monoliners, as we called these bond insurers. Well, maybe not ALL their fault, but they were the catalyst.
Basically, back in 2001, banks in the USA were eager to lend money. There were two slight problems here. One was that the general principle of lending money (if you are a bank) is that someone has to lend YOU money first. Banks are in theory intermediaries between savers and borrowers. Capital ratio requirements meant that you had to keep capital on your books. Triple A-rated borrowings were best, because they imposed least strain on your capital. Unfortunately, although there were plenty of C-minus potential borrowers around (although these were more optimistically classed as in the B range), there weren't that many triple A borrowers.
Step forward MBIA. "No problem", the monoliner said. "You lend the money, pay us a fee, and we'll guarantee it if the borrower defaults. We are triple A-rated, so, as far as you (the bank) are concerned, it's a triple-A loan, not a pile of cack."
"Great", said the bank. "We'll have some of that". And so, for a fee payable to MBIA, or Ambac, the bank could lend much more than it did before.
Unfortunately, this wasn't enough. Wouldn't it be better if the loan could be sold on for a fee? That way, the bank got the fee rather than the monoliner. And so the collateralized mortgage obligation took off. Banks lent money, packaged up the loan with other loans, sliced it up into good layers, not so good layers, and crap layers, and sold this on to mug investors such as AIG, German and French banks, etc. And these French and German banks insured the investment with, guess who, yes, the monoliners. Perhaps you can see a theme developing here.
What the Treasury has realized is that it was only because the monoliners couldn't pay when the CMOs defaulted that the whole thing went tits up.
And so we have the government becoming a monoliner. And, of course, governments are triple A rated, which means that the banks can start lending again, which means...
Hang on, isn't this how the whole problem started in the first place?
Because, of course, and no-one likes to mention this, there were only a few people around in the early 2000s (and by 2003 I had followed Dennis Mahoney at Aon in becoming one of them) who wondered what would happen if the monoliners stopped being triple-A rated. Well, we have now seen what happens.
The assumption implicit in the UK government "guaranteeing" these toxic debts is that the government's guarantee is solid. The hope on the UK Government's side will be that it's mere issuance of a guarantee will mean that the guarantee will never have to be deployed. But, then again, that was what MBIA hoped as well.
But herein lies another problem, because another country has been down this road already. See Ireland. Last September Ireland thought it was being awfully clever in guaranteeing all bank deposits and funding. By doing so, it reasoned, funds would stay in Ireland (indeed, a lot of "clever" money made its way from the UK to Ireland because of this guarantee) and the cost to the Irish Treasury would be zero. Indeed, it did fuck-all to inject capital into Ireland's banks. The Irish line was, as it were, the archetypal belief that this was a crisis of confidence rather than a systemic problem.
Once it became clear that there was a systemic problem as well, Ireland didn't know what to do. From making the first move it fell rapidly away, like so many young Irish greyhounds, and did not come up with rescue details until December. Leaving aside Bank of Ireland and Allied Irish for the moment, it also planned to put €1.5bn into Anglo Irish, in return for a 75% stake.
But it was too late. Last Tuesday the entire Irish banking system was probably only a few days away from collapse, and Ireland had to step in and nationalize Anglo Irish. Meanwhile, despite the guarantees of the Irish government, Bank of Ireland and Allied Irish have a price-to-earnings ratio of about one. Not many people have faith in the Irish banking system any more, and that means that a few people are dubious about the strength of the Irish government's "guarantee".
This kind of doubt could easily emerge in the UK and, god forbid, the US markets. One thing that would delay a total collapse would be the lack of Taleb-like thinkers at the rating agencies. Fitch and Fitch alone might have the courage to say "Hold on, but are these western governments REALLY less likely to default than Argentina, or Ecuador?" Now, suppose the UK government fell into this category. At that point its guarantee to UK banks would cease to be triple A, which would require the banks to obtain more capital (once again, see AIG) but by now there wouldn't be any viable candidate to step up to the plate to provide that capital. One day, the buck really will have to stop.
__________________
And then, in a move which seems to make a nonsense of Brown's urging anyway (discord between the BoE, the Treasury and the prime minister? Heaven forbid) the new wheeze is to turn the Bank of England into a new version of Ambac, or MBIA.
So, let's step back a bit and see roughly how this mess started, because it's all the fault of the monoliners, as we called these bond insurers. Well, maybe not ALL their fault, but they were the catalyst.
Basically, back in 2001, banks in the USA were eager to lend money. There were two slight problems here. One was that the general principle of lending money (if you are a bank) is that someone has to lend YOU money first. Banks are in theory intermediaries between savers and borrowers. Capital ratio requirements meant that you had to keep capital on your books. Triple A-rated borrowings were best, because they imposed least strain on your capital. Unfortunately, although there were plenty of C-minus potential borrowers around (although these were more optimistically classed as in the B range), there weren't that many triple A borrowers.
Step forward MBIA. "No problem", the monoliner said. "You lend the money, pay us a fee, and we'll guarantee it if the borrower defaults. We are triple A-rated, so, as far as you (the bank) are concerned, it's a triple-A loan, not a pile of cack."
"Great", said the bank. "We'll have some of that". And so, for a fee payable to MBIA, or Ambac, the bank could lend much more than it did before.
Unfortunately, this wasn't enough. Wouldn't it be better if the loan could be sold on for a fee? That way, the bank got the fee rather than the monoliner. And so the collateralized mortgage obligation took off. Banks lent money, packaged up the loan with other loans, sliced it up into good layers, not so good layers, and crap layers, and sold this on to mug investors such as AIG, German and French banks, etc. And these French and German banks insured the investment with, guess who, yes, the monoliners. Perhaps you can see a theme developing here.
What the Treasury has realized is that it was only because the monoliners couldn't pay when the CMOs defaulted that the whole thing went tits up.
And so we have the government becoming a monoliner. And, of course, governments are triple A rated, which means that the banks can start lending again, which means...
Hang on, isn't this how the whole problem started in the first place?
Because, of course, and no-one likes to mention this, there were only a few people around in the early 2000s (and by 2003 I had followed Dennis Mahoney at Aon in becoming one of them) who wondered what would happen if the monoliners stopped being triple-A rated. Well, we have now seen what happens.
The assumption implicit in the UK government "guaranteeing" these toxic debts is that the government's guarantee is solid. The hope on the UK Government's side will be that it's mere issuance of a guarantee will mean that the guarantee will never have to be deployed. But, then again, that was what MBIA hoped as well.
But herein lies another problem, because another country has been down this road already. See Ireland. Last September Ireland thought it was being awfully clever in guaranteeing all bank deposits and funding. By doing so, it reasoned, funds would stay in Ireland (indeed, a lot of "clever" money made its way from the UK to Ireland because of this guarantee) and the cost to the Irish Treasury would be zero. Indeed, it did fuck-all to inject capital into Ireland's banks. The Irish line was, as it were, the archetypal belief that this was a crisis of confidence rather than a systemic problem.
Once it became clear that there was a systemic problem as well, Ireland didn't know what to do. From making the first move it fell rapidly away, like so many young Irish greyhounds, and did not come up with rescue details until December. Leaving aside Bank of Ireland and Allied Irish for the moment, it also planned to put €1.5bn into Anglo Irish, in return for a 75% stake.
But it was too late. Last Tuesday the entire Irish banking system was probably only a few days away from collapse, and Ireland had to step in and nationalize Anglo Irish. Meanwhile, despite the guarantees of the Irish government, Bank of Ireland and Allied Irish have a price-to-earnings ratio of about one. Not many people have faith in the Irish banking system any more, and that means that a few people are dubious about the strength of the Irish government's "guarantee".
This kind of doubt could easily emerge in the UK and, god forbid, the US markets. One thing that would delay a total collapse would be the lack of Taleb-like thinkers at the rating agencies. Fitch and Fitch alone might have the courage to say "Hold on, but are these western governments REALLY less likely to default than Argentina, or Ecuador?" Now, suppose the UK government fell into this category. At that point its guarantee to UK banks would cease to be triple A, which would require the banks to obtain more capital (once again, see AIG) but by now there wouldn't be any viable candidate to step up to the plate to provide that capital. One day, the buck really will have to stop.
__________________
