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It’s fascinating to see how much everyone around the globe is presently applauding Gordon Brown, the UK’s PM, for coming up with “the plan” to rescue us from the economic meltdown. Features of this plan are now being adopted by other governments in need of a magic wand to get them out of the financial abyss.

UK plans: The plan amounts to the UK Government formally taking a stake in UK’s banks whilst giving them money (£37bn to three named banks – RBS, Lloyds and HBOS) to recapitalise and hence become more resistant to the current market volatility and the ongoing liquidity crisis.

This was received exceptionally well by the world’s markets. FTSE 100 is positively rocketing upwards – on Friday it closed below 3,900, it now stands at 4,400, up well over 12% in just 2 nerve-wracking days. European and Asian indices are also up very strongly.

US adjust the approach: US’s bailout package of $700bn, which was originally intended just to buy off bad debts off failed banks, was badly received by the markets earlier in October and failed to stem the fall of american indices which dragged the world’s markets down with it. Now the US government is turning towards the UK-style idea and is planning to recapitalise 9 banks (amongst them Goldmans and Morgan Stanley) using $250bn of the bailout pack for this.

This will be deeply humiliating to Goldmans and Morgan Stanley which until now have been the last 2 “pure” investment banks left on Wall Street. Goldmans, in particular, was initially trying to raise its own capital to ensure its survival, whilst Morgan Stanley was looking for a merger. I wrote about that earlier in Sept.

US markets strongly welcomed US’s change in thinking on the rescue plan and Dow Jones is finally on the up.

Knight in shining armour? Gordon Brown is getting credited for coming up with the plan that is going to work, where all else failed to date. Paul Krugman who got awarded the Nobel prize for economics, has been praizing Mr Brown as the one who might have saved the world’s financial system: more details here.

But we must not forget, before we get carried away on the sudden euphoric wave, that:

  • Gordon Brown failed to prevent UK entering the credit spending spree in the first place, creating conditions for a very sharp comedown to earth which are only starting to bite now
  • He failed to get the regulators involved when alarm bells have been ringing for months as banks were increasingly entrenched in runaway activities which were hardly regulated

And thus we must consider Gordon Brown’s achievements and undoubted strong leadership skills in the last few days in light of the fact that really, we should not have been here in the first place.

What is always impressive is the well-oiled Labour spin machine which helps Mr Brown deliver his recent “save the banking world” speeches so very well. UK is newly rebranded as “rock of stability and fairness”. The stuff that would normally make one cringe was swallowed by this week’s hungry for reassurance markets, hook line and sinker.

A very bitter pill: As for the bailout itself –  no-one likes the sound of it. In fact we all loathe the sound of it. And I for one thought in the last month, just let these banks fail, as “damned if you do, damned if you don’t” – bailout or not bailout – it will hurt in both cases. But economic tools and alternatives being rather thin on the ground, I agree with some of my recent commentators, I have come round to semi-accepting the inevitability of this bailout. This is mainly because everything else I have seen suggested would have implied an HUGE social and economic upheaval. Like write off everyone’s debt and assets, for instance.

What this means is that as the world’s order is shifting towards quasi-socialist principles and a very strong government hand in regulation, we are not trying to shake the foundations of the existing society. Call me a coward but I don’t feel there is a call for that at this stage.

Yet from the UK’s point of view, it is extremely disappointing to see Gordon Brown take so much credit for an event that he did not manage to prevent.


Copyright 2008 by CuriouslyInspired

Yesterday two major investment banks suffered a steep fall in their share prices following a continuing slump in investor confidence. To survive, banks need to raise a large amount of cash, something that is extremely challenging at present due to the credit crunch – no-one is prepared to lend money to troubled institutions.

The problem with Goldmans took most by surprise as its trading results have been strong. However rumours about Morgan Stanley’s large bad loan portfolio have been circulating for a while.

The two banks are the only remaining institutions that focus entirely in the investement banking business, with currently no involvement in commercial (retail) banking.

Separation of investment and commercial banking: In the 1930s, the Glass-Seagall act was passed in the USA which separated commercial banks (which take deposits and make loans), from investment banks (which trade securities). The investment banks were allowed to do business with less oversight, while commercial banks were tightly regulated. This law was repealed in 1999, and as the result commercial and investment banks started merging their operations.

Cause of the Credit crunch: It’s a simplified story, but here goes: Increased competition between banks in the last 10 years put pressure on profit margins and forced investment banks to start getting very creative with complex and risky financial instrument strategies. Credit derivatives were born and exploded exponentially as the major growth area in financial markets. At some stage recently they started getting packaged up into complicated bundles of credit instruments, the risk on which was incorrectly assessed by the market. When bad debts on the US mortgage market started mounting up due to customer defaults in the last couple of years, banks started seeing the complex credit instruments sitting on their books turning worthless and becoming bad debts on a major scale. As banks were all exposed and started suffering from the same problem, they all grew reluctant to lend spare cash to each other, preferring to hold onto it in case of further trouble. This effect rippled right through the system and resulted in retail banks being reluctant to lend money to customers like you and I. The Credit Crunch was born.

Morgan Stanley strategy: Both Morgan Stanley and Goldmans, and other investment banks were heavily exposed in their credit investment portfolios. As the result of yesterday’s share price falls of 24%, Morgan Stanley is now seeking a merger to secure its survival. It is now in talks with Wachovia bank and also with Chinese sovereign wealth fund – China Investment Corp (CIC). CIC already owns 9.9% Morgan Stanley. Reportedly, Morgan Stanley has $120bn of “toxic” mortgage assets on its balance sheet. A merger with a retail bank will diversify Morgan Stanley’s pure investment banking focus.

Goldmans Sachs is denying that it is looking for a merger. The FT has some good commentary about Goldman’s opportunity to consolidate its strength in the investment banking sector, if it somehow manages to raise capital and weather the storm without resorting to a merger: see link


December 2019
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