![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
Debtor's Prism
Jun. 11th, 2011 02:56 pmWhile looking through Bloomberg for some insurance stories (I'm trying to write up as much as possible to keep 'in reserve' for the next few days that I am suffering poolside in Bermuda), I came across an interesting story about debt. This matched up with another interesting story about debt this morning from Merryn Somerset Webb, and links in (of course) with the eurozone sovereign debt disaster.
On the Greek front, the FT reports this morning that the French banks have agreed in principle to buy new issues of Greek sovereign debt (see Aardvark's perceptive comment on my previous post below, about a 'buying and selling' trick) on conditition that all creditors do the same. I'm not sure how much the French banks and the French government are singing from the same hymn sheet here, but if we assume that the French banks will toe the line, we have an interesting situation where the German finance minister Wolfgang Schauble appears to be arguing one thing, and the French finance minister (currently Christine Lagarde - the irony) is arguing another.
To my way of thinking it is Schauble who is talking sense here, while the French (and the ECB) are looking for any way they can to keep up the pretence that Greece is not insolvent. I.E., keep the debt as 'clean' according to the rating agencies, rather than in default. Schauble meanwhile has been backed by the Dutch (and presumably by the Belgians, if they had a government, but I don't think they have). The FT quoted one annonymous French banker who seemed to indicate that they (a) would toe the line and (b) they weren't happy about it.
Well, not so much the unknown, because what is now becoming clear (to me, at least, and I guess to quite a few people in the banking industry) is that we are entering a global situation akin to the Chinese banking non-performing-loan disaster of the late 1990s. The only question is when it will blow up and what we will do when it does.
I use the word 'global' rather than eurozone deliberately, because Somerset Webb and Bloomberg showed this morning that this rollover of Greek debt -- little more than a pretence that a non-perfoming-loan is actually a performing loan (and remember how this fits in with what I said a couple of years about the accountancy rules being changed to stop the shit hitting the fan) is being reflected elsewhere in the global economy.
Somerset Webb quote Jonathan Pierce, who left Crédit Suisse this week. In a closing email to clients he wrote that there was a significant "tail risk in credit portfolios". That is bank speak for "a lot of the loans that banks are pretending are fine are in fact shit". Indeed, it would appear that the UK banking system has been in indulging in its own version of "reprofiling" of UK property debt (which is roughly in the same situation as Spanish sovereign debt, but is definitely better than Spanish and Irish property debt).
The key number that Pierce comes out with, the "smoking gun" as it were, is that banks, which for three years have put the block on interest-only loans, now have £110bn more in interest-only loans than they did in 2007. How can this be? No need to put the answer on a postcard, because Somerset Webb tells us. Banks have quietly been converting what are likely to become or have already become non-performing repayment loans into interest-only loans, making it less likely that the borrowers will default in the next 12 months. It also means that these loans can still be counted as "good", which in turn means that banks are not required to accumulate more capital. No wonder that they are encouraging me to pay off capital on my own interest-only deal (even though my fixed rate is a (for me) disasterous 5.89%). Every pennny that I pay off of my capital permits them to put off the evil day that they have to mark down other loans as non-performing. They want me to pay off a 5.89% loan so that they can, effectively, lend it out at 3.5%, because this makes their numbers look better. Catch-22 economics indeed.
Somerset Webb comes up with her own interesting number. Apparently one of the big five banks (let's assume it was RBS, although I am only guessing -- it might have been Lloyds) went to a private equity group offering £1bn of second-grade consumer debt. The bank wanted 85p in the £. The private equity team reckoned that it was worth no more than 35p in the £.
That's a frightening differential (and that book of loans is still being counted at 100p in the £ on that bank's books) and in technical terms it's known as 'head in the sand' economics. Just pretend it isn't there.
Somerset Webb makes all of these points to argue against buying bank shares. I'm not sure about that, TBH. Just because a stock is going to be a dead duck in the long term doesn't mean it will be a dead duck tomorrow. I have no bank shares myself, but I wouldn't be a panic seller, not just yet. But her argument has deeper macro-economic consequences. Think about that £1bn of second-grade debt, currently valued at £1bn (even though the bank wanted only £850m when it was thinking of selling it). What does that imply for the UK banking system? Well, the total UK personal debt is about £1,454bn. How much is this actually worth? Well, if we are in the land of educated guesswork, I would say that, if it was marked to market today, it would be worth no more than £1,000bn. That means there's £454bn of money being counted at 100% that actually doesn't exist. If we transfer that through to all adults (which includes pensioners, who are currently ring-fence protected from feeling any of the pain) that comes out at about £8,000 per person. Or about £13,000 per 'economically productive' person.
Well, that's either a lot, or not a lot. It's not a lot on its own, but it's only a small part (and a completely unrecognized one) of our greater unsustainable economic situation. If we look at it in terms of the banks' capitalization, it's rather worse. HSBC, a global bank with global problems, is our largest bank in terms of market capitalization, and it's not much higher than £50bn, I reckon. In other words, the banks in the UK are not going to be paid back rather more than their total current market capitalization. Whoops. No wonder Merryn is a bear on UK bank equity.
Now, this "the debt is a much bigger problem than we realized" phenomenon has emerged in the US in an odd way. AIG, that poor US insurer that involuntarily bailed out the US and European banking systems in 2008 and 2009, wanted to buy back the "Maiden Lane" portfolio of 'bad' debt from the Fed (it was this Maiden Lane vehicle that was put together to facilitate the AIG rescue). The Fed rejected the AIG offer of $15.7bn, reckoning that it could get more on the open market. This, it turns out, was a dumb move. There has been a huge sell-off in the credit markets in the past month, with credit-default swap indices dropping by some 20%. All this is rather complex stuff, but it looks as if the dribbling of Maiden Lane debt onto the market was rather more dubious second-grade debt than the market wanted to swallow. Combined with a few bits of bad macro-economic data in the US, and the realization that the Greek crisis might find its way back to the US markets via European banks' own CDS moves, and you had a recipe for a move into risk-aversion. Everyone suddenly wanted to cover their arse against their credit going bad.
And, of course, it's in banks' interest to insure against a loan going bad rather than to sell the loan at 85% (or 35%...). In the former case you can say 'the loan is good, but we are being prudent in case it turns out not to be good', whereas in the latter, you have to say 'ok, the game's up, the loan is shit.'
How does this all pan out? well, we have to keep an eye on indices that we haven't looked at that closely before, because the banks sure as hell won't tell us what they are up to. One of these indices is the Markit CDX North American Investment Grade Index, which is currently at 99bps. It's a crude measure, but it will have positive correlation with what banks are doing with their own dodgy debts. At the moment the index means that the average cost of protecting against $10m of investment grade debt in the US is $100,000 a year. If the index goes up, it's costing you more to protect yourself. Mortgage debt comes in with Markit ABX and Markit CMBX. Other indices include BofA Merrill Lynch Global Broad Market Corporate Index (159bps, up 14bps since mid-April). All of these indices since mid-April have shown that investors are rushing to protect themselves against loans going bad. But who is doing the selling? Well, I can think of a few players -- long-term assurers might be taking on this risk, for example (looking for a little bit of extra yield). Unfortunately, these aren't indices that you will hear on 'Wake Up To Money'.
But, keep that £454bn in mind. remember that this is just the UK. Multiply that out through the eurozone and the US. Figure out the implications of every adult in the UK spending £8,000 less over the next few years. It certainly doesn't look pretty.
__________
On the Greek front, the FT reports this morning that the French banks have agreed in principle to buy new issues of Greek sovereign debt (see Aardvark's perceptive comment on my previous post below, about a 'buying and selling' trick) on conditition that all creditors do the same. I'm not sure how much the French banks and the French government are singing from the same hymn sheet here, but if we assume that the French banks will toe the line, we have an interesting situation where the German finance minister Wolfgang Schauble appears to be arguing one thing, and the French finance minister (currently Christine Lagarde - the irony) is arguing another.
To my way of thinking it is Schauble who is talking sense here, while the French (and the ECB) are looking for any way they can to keep up the pretence that Greece is not insolvent. I.E., keep the debt as 'clean' according to the rating agencies, rather than in default. Schauble meanwhile has been backed by the Dutch (and presumably by the Belgians, if they had a government, but I don't think they have). The FT quoted one annonymous French banker who seemed to indicate that they (a) would toe the line and (b) they weren't happy about it.
"It would be changing the rules of the game in the eurozone and we would be journeying into the unknown",he said.
Well, not so much the unknown, because what is now becoming clear (to me, at least, and I guess to quite a few people in the banking industry) is that we are entering a global situation akin to the Chinese banking non-performing-loan disaster of the late 1990s. The only question is when it will blow up and what we will do when it does.
I use the word 'global' rather than eurozone deliberately, because Somerset Webb and Bloomberg showed this morning that this rollover of Greek debt -- little more than a pretence that a non-perfoming-loan is actually a performing loan (and remember how this fits in with what I said a couple of years about the accountancy rules being changed to stop the shit hitting the fan) is being reflected elsewhere in the global economy.
Somerset Webb quote Jonathan Pierce, who left Crédit Suisse this week. In a closing email to clients he wrote that there was a significant "tail risk in credit portfolios". That is bank speak for "a lot of the loans that banks are pretending are fine are in fact shit". Indeed, it would appear that the UK banking system has been in indulging in its own version of "reprofiling" of UK property debt (which is roughly in the same situation as Spanish sovereign debt, but is definitely better than Spanish and Irish property debt).
The key number that Pierce comes out with, the "smoking gun" as it were, is that banks, which for three years have put the block on interest-only loans, now have £110bn more in interest-only loans than they did in 2007. How can this be? No need to put the answer on a postcard, because Somerset Webb tells us. Banks have quietly been converting what are likely to become or have already become non-performing repayment loans into interest-only loans, making it less likely that the borrowers will default in the next 12 months. It also means that these loans can still be counted as "good", which in turn means that banks are not required to accumulate more capital. No wonder that they are encouraging me to pay off capital on my own interest-only deal (even though my fixed rate is a (for me) disasterous 5.89%). Every pennny that I pay off of my capital permits them to put off the evil day that they have to mark down other loans as non-performing. They want me to pay off a 5.89% loan so that they can, effectively, lend it out at 3.5%, because this makes their numbers look better. Catch-22 economics indeed.
Somerset Webb comes up with her own interesting number. Apparently one of the big five banks (let's assume it was RBS, although I am only guessing -- it might have been Lloyds) went to a private equity group offering £1bn of second-grade consumer debt. The bank wanted 85p in the £. The private equity team reckoned that it was worth no more than 35p in the £.
That's a frightening differential (and that book of loans is still being counted at 100p in the £ on that bank's books) and in technical terms it's known as 'head in the sand' economics. Just pretend it isn't there.
Somerset Webb makes all of these points to argue against buying bank shares. I'm not sure about that, TBH. Just because a stock is going to be a dead duck in the long term doesn't mean it will be a dead duck tomorrow. I have no bank shares myself, but I wouldn't be a panic seller, not just yet. But her argument has deeper macro-economic consequences. Think about that £1bn of second-grade debt, currently valued at £1bn (even though the bank wanted only £850m when it was thinking of selling it). What does that imply for the UK banking system? Well, the total UK personal debt is about £1,454bn. How much is this actually worth? Well, if we are in the land of educated guesswork, I would say that, if it was marked to market today, it would be worth no more than £1,000bn. That means there's £454bn of money being counted at 100% that actually doesn't exist. If we transfer that through to all adults (which includes pensioners, who are currently ring-fence protected from feeling any of the pain) that comes out at about £8,000 per person. Or about £13,000 per 'economically productive' person.
Well, that's either a lot, or not a lot. It's not a lot on its own, but it's only a small part (and a completely unrecognized one) of our greater unsustainable economic situation. If we look at it in terms of the banks' capitalization, it's rather worse. HSBC, a global bank with global problems, is our largest bank in terms of market capitalization, and it's not much higher than £50bn, I reckon. In other words, the banks in the UK are not going to be paid back rather more than their total current market capitalization. Whoops. No wonder Merryn is a bear on UK bank equity.
Now, this "the debt is a much bigger problem than we realized" phenomenon has emerged in the US in an odd way. AIG, that poor US insurer that involuntarily bailed out the US and European banking systems in 2008 and 2009, wanted to buy back the "Maiden Lane" portfolio of 'bad' debt from the Fed (it was this Maiden Lane vehicle that was put together to facilitate the AIG rescue). The Fed rejected the AIG offer of $15.7bn, reckoning that it could get more on the open market. This, it turns out, was a dumb move. There has been a huge sell-off in the credit markets in the past month, with credit-default swap indices dropping by some 20%. All this is rather complex stuff, but it looks as if the dribbling of Maiden Lane debt onto the market was rather more dubious second-grade debt than the market wanted to swallow. Combined with a few bits of bad macro-economic data in the US, and the realization that the Greek crisis might find its way back to the US markets via European banks' own CDS moves, and you had a recipe for a move into risk-aversion. Everyone suddenly wanted to cover their arse against their credit going bad.
And, of course, it's in banks' interest to insure against a loan going bad rather than to sell the loan at 85% (or 35%...). In the former case you can say 'the loan is good, but we are being prudent in case it turns out not to be good', whereas in the latter, you have to say 'ok, the game's up, the loan is shit.'
How does this all pan out? well, we have to keep an eye on indices that we haven't looked at that closely before, because the banks sure as hell won't tell us what they are up to. One of these indices is the Markit CDX North American Investment Grade Index, which is currently at 99bps. It's a crude measure, but it will have positive correlation with what banks are doing with their own dodgy debts. At the moment the index means that the average cost of protecting against $10m of investment grade debt in the US is $100,000 a year. If the index goes up, it's costing you more to protect yourself. Mortgage debt comes in with Markit ABX and Markit CMBX. Other indices include BofA Merrill Lynch Global Broad Market Corporate Index (159bps, up 14bps since mid-April). All of these indices since mid-April have shown that investors are rushing to protect themselves against loans going bad. But who is doing the selling? Well, I can think of a few players -- long-term assurers might be taking on this risk, for example (looking for a little bit of extra yield). Unfortunately, these aren't indices that you will hear on 'Wake Up To Money'.
But, keep that £454bn in mind. remember that this is just the UK. Multiply that out through the eurozone and the US. Figure out the implications of every adult in the UK spending £8,000 less over the next few years. It certainly doesn't look pretty.
__________
