The banks could now make Britain go bust
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Associate Editor
David Stevenson Feb 16, 2009
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The Crunch is about to bite again.
First, the US housing market nose-dived, racking up huge sub-prime loan losses for the banks. They cut their customers' credit lines, passing on the pain to the rest of the world economy. Property prices and stockmarkets plunged.
Bad enough. Yet the more we discover about all the lousy loans the lenders have made, the worse they look. So governments are backstopping the banks – but even that may not do the trick.
Whole countries could now go bust. Don't believe any 'green shoots' talk - there's plenty more bad news on the way...
The foundations of the financial system are rocking
The weekend saw even more heavy-duty media coverage about British banks' latest problems. Maybe that's surprising. After all the mega financial write-offs we've seen, you might not have expected even the record £10bn HBOS horror loss to top the headlines.
But the hits are now big enough to rock the system's foundations. The parlous state of HBOS' finances – and who knows how many other nasties are lurking in the balance sheet? - means the merger to form the Lloyds Banking Group is "unravelling rapidly in the eyes of the City", says the Sunday Telegraph. They quote one shareholder as saying that "this is increasingly looking like a disaster zone of a deal".
So what's the likely next step from the UK government?
Yes, you've guessed it. More public cash. The British taxpayer looks like increasing his bank portfolio with a majority stake in LBG to add to the controlling slice in RBS.
It's the same story the world over. The planet's politicians have developed such a taste for spending our money, they no longer think twice about it. They've convinced themselves they're the only people who can save the world by bailing out the biggest banks. Regardless of cost.
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And yes, some politicians can get away with it, at least short-term. Several US banks may be on the brink, but because the dollar's the global 'reserve' currency, i.e. the 'go to' safe haven when things turn unpleasant, the American government has managed to bail most of them out without a panic that the States is going under.
But the smaller fry aren't so lucky. As more banks worldwide look like folding and their governments act as back-stop, the numbers are getting too big even for whole countries to handle. And the risk of default, i.e. those countries not being able to make repayments on the bonds they've sold to investors, will rise.
First Iceland – now other countries may follow
We've already seen what happened to Iceland, whose banks had borrowed several times the country's GDP in foreign currencies. When the markets finally clocked what was going on, Icelandic banks had to be nationalised, the krona collapsed, and Iceland became insolvent.
OK, that may be extreme, as Iceland had morphed into a less-than-glorified hedge fund, buying up large chunks of the British high street at far too high a price. And in other parts of the world – Latin America springs to mind – investors have learnt to expect sovereign debt defaults as an occupational hazard.
But rather closer to home, last week's news that the Irish government had been forced to plough €7bn into propping up the country's banks really spooked the financial markets.
"Pledges made by Ireland to support its banking sector now amount to 220% of annual GDP", says the Sunday Times, "the total loans held in Irish banks are now more than 11 times the size of the economy. Debt market investors now rank Ireland as the most troubled economy in Europe, as fears are rising that Ireland could default". No wonder the cost of insuring against non-payment of Irish government bonds has hit record levels.
Then there's Eastern Europe, "increasingly viewed as Europe's sub-prime debacle - and EU banks have $1.6trn of exposure", says Ambrose Evans-Pritchard in the Telegraph. Indeed, last week the paper published excerpts from a "confidential European commission memo" which suggested that "the toxic debts of European banks risk overwhelming a number of EU governments" if they underwrite their banks liabilities.
More shocks to come: sell while you can
What about the UK itself? The pound has been plunging as international investors have got the jitters about British banks' $4.4trn of external liabilities. Add a large chunk of these to our other national borrowings, and we could reach a point where we can't raise the money to pay the bills. What's more, we have form. Don't forget in 1976, we had to call the IMF for help.
And at the weekend's G7 Rome summit, there was a dire warning from IMF chief Dominique Strauss-Kahn that a "second wave of countries will come knocking" for bailouts. Scary? Very. Bailouts are very bad news for investors. Yet if sovereign states default en masse, it would have a devastating domino effect on global financial market confidence. Perhaps the odd UK government minister may detect "green shoots". This feels much more like the slippery slope.
It all points to financial markets having a lot more shocks in store. And any stockmarket rallies should be used as a chance to sell anything you're remotely worried about...
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