The Fall of Northern Rock

The book is peppered with confessions of ignorance. He picked up not a single warning signal from the beginning of the debacle to the end. In early 2007, he thought nothing could stop the bank’s “fantastic progress”. When the share price started to fall later in the year, he assumed, along with his colleagues, that the media, jealous of the bank’s previous successes, had “it in” for it.

Walters knew little of the bank’s funding methods and was “blissfully unaware” that the sub-prime crisis in America might threaten Northern Rock – as, indeed, were his bosses, who launched a new discount tracker for buy-to-let investors in August 2007. And even in early September, just before all hell broke loose in Newcastle, he was busy flying off for a holiday in San Francisco with, as he says himself, very little idea of “what was really going on behind the scenes”.

It all seems rather extraordinary given that, although he wasn’t exactly a board director, Walters was head of commercial lending for the Leeds office, and given that even the most junior of financial journalists and analysts across the City had a very good idea of exactly what was going on behind the scenes.

Still, compare it with this week’s debacle – the profits warning and bungled rights issue at Bradford & Bingley (B&B) – and it doesn’t seem so odd after all. It looks like a mixture of total lack of awareness and mild stupidity is par for the course across the UK banking sector. Just like Northern Rock, B&B has clearly spent the last few years in total denial – refusing to accept that the housing market was in a bubble and hence fuelling the fire of its own destruction by providing the credit to keep the bubble growing.

And just like Northern Rock, senior management appeared to be blissfully unaware of the all-too-obvious risks to their business. At the start of this year, even as volumes – the canary in the coal mine to the housing market – collapsed across the country, B&B announced that it was relying on growth in its buy-to-let business to keep things going. Whoops.

But just as delusional as the bankers are those who were still holding B&B shares on Monday when their bad news at last appeared. Who didn’t know about the credit crunch? That buy-to-let in Britain is bust? That falling house prices and rising mortgage rates always lead to arrears and defaults? And who had forgotten that bubbles always end in corruption (B&B also announced on Monday that they’d lost £15m to mortgage fraud)? You might want to check one of them isn’t running your pension fund.

Source: Make Sure You Check Who’s Running Your Funds

Nicholas Nassim Taleb coined the term Black Swan to explain how massive unforeseen events have the greatest impact on markets. But only the most naïve and optimistic of investors was not expecting further fallout from the abominable banking sector.

Bradford & Bingley (B&B), like Northern Rock, RBS, Alliance & Leicester, Barclays and HBOS before it, is in the spotlight and in a lot of trouble.

The company has launched a £258m rights issue at an offer price of 55p a share. They are set to issue a profit warning. Steven Crawshaw has stepped down as CEO. And they have agreed to sell 23% of their shares to Texas Pacific Group (TPG) Capital, a US private equity firm for £179 million.

This “perfect storm” hit the firm so hard that the FSA were forced to come in and suspend trading in the shares.

The downturn in the buy-to-let housing market means the UK’s eighth largest bank, from £3 billion in 2006, now is worth a mere £404m — less than Dignity funeral care. Which is shocking, viewed in isolation.

But, I’m pretty blasé about all of these rights issues and share plunges. Anything happening in the banking sector is a write-off (pun intended). Regular readers know that I’ve no interest in bottom-fishing for ‘bargain’ banks.

Despite my antipathy, I have been constantly advised to pile into banking shares. In the past 3 months I’ve been told:

To buy Barclays at 510p; the shares are now 363p;
To buy RBS at 330p; now 222p;
And to buy HBOS at 497p; now 368p.

All three tips were made, among other things, on the basis of big dividend yields, which seem to cover a multitude of sins.

Except they don’t. All three tips have incurred a greater capital loss than their total annual dividend payout would compensate for. And, none of these three firms is paying a dividend in cash. They’re paying them in shares instead.

This only serves to hurt the per share profitability, which lowers the already low share price… not what the dividend hunters signed up for.

The world’s worst stock tipper

I will no doubt receive another tip for Bradford & Bingley. Why do the tippers persevere with banks?

Because the culprit ultimately responsible for all of these tips is still at large, pushing bank stocks like never before.

Let me now reveal to you who that culprit is. This is today’s the print-out from my Bloomberg terminal, objectively ranking stocks by their value credentials:

1. Bradford & Bingley, Score: 99:89
2. Alliance & Leicester, Score: 83.96
3. HBOS, Score: 80:86
4. Barclays, Score: 78.68
5. RBS, Score: 76.42

Blame the machines.

Across the entire UK stock market, banks are the five best value investments around today. And it’s not just Bloomberg… running any value ‘stock screen’ from Reuters, to Digital Look, to Zacks, to ADVFN produces the same result. This is what every investor and fund manager has been seeing on their screens since late-October.

In objective terms, these are the shares to buy. But anyone who’s been following this advice over the last 12 months has lost, and lost big.

There are two ways to look at investments, bottom-up and top-down.

Bottom-up investing uses stock-screens — systems that zero-in on company fundamentals. Think of it as tunnel-vision investing. In a bull-run, it is a great way to buy stocks. I used to build stock screens for a critically-acclaimed investment service, so I can personally testify to how effective they can be.

Top-down investing is quite different. This method is far more big picture. The first question is not ‘What company should I look at?’ It’s ‘What assets should I look at?’

Top-down investors are not only looking at numbers, but at sentiment and market opportunities outside of a machine’s scope.

While neither method is perfect, in a market downturn it is essential to think big.

Bottom-up investing can lag reality — in the 2000 bear market, stock screeners were picking out the companies that had fallen hard and were more value trap than value opportunity. The same thing is happening here. A system is not a substitute for common sense.

If the market falls by 20%, you have to sit up, take notice and, depending on the portfolio, take action.

The fallout was an opportunity to re-evaluate and find safe-havens for your money. Those who did this have profited in the last six months. Those who had well diversified portfolios in a variety of sectors have probably broken even.

Those who held the ‘good value’ banks, house-builders and retail stocks must now take drastic action to pull things back.

Theo Casey

Source: Bradford And Bingley’s White Swan Event

Good day… And a Marvelous Monday to you! And welcome to June! Hey! June is busting out all over, all over the meadow and the field… Buds are busting out of bushes and the rompin’ river pushes every little wheel that wheels beside the mill! (And you thought I was just a rocker!) We are having network problems this morning, as some heavy storms ripped through St. Louis on Saturday night. So, the Techie people need to come in and get stuff re-booted, etc. This may go out late… And it may not… At this point, I at least have my laptop working!

Well… Friday saw little movement in the currencies… As I signed off I had told you that maybe someone had said “enough” with the euro (EUR) selling… As the day went on, it certainly looked like that had happened, given the euro’s rise to 1.5550, after looking up to 1.55 early in the morning.

There’s been a return to risk aversion overnight, as some news from the United Kingdom has reignited the fears that the banks may still be sitting on a ton of bad debt… Of course, as Pfennig readers, you already know this, as I’ve told you over and over again there are many more “risk events” for the markets to digest.

Here’s the skinny on the U.K. news… The United Kingdom’s largest lender of buy-to-let mortgages, Bradford & Bingley, came forward to reveal that they had booked a pre-tax net loss of 8 million pounds (after accounting for reductions in the value of its structured investment assets. They also announced that they were going to restructure, and that TPG, Inc. would invest about 179 million pounds.

Well… There you have it… More melting of the U.K. mortgage meltdown… But, hear me now and listen to me later, this isn’t isolated to the United Kingdom.

This is a Big Central Bank meeting week around the world, with the Reserve Bank of Australia (RBA) meeting Tuesday, the Reserve Bank of New Zealand (RBNZ) meeting Wednesday, the Bank of England (BOE) and European Central Bank (ECB) meeting on Thursday. I don’t expect any of these to move rates one way or another at this time. There’s a tiny light shining on the RBA to raise rates, but I think that will come at a later date.

As always, with an unchanged rate environment, the press conference following the meetings will be the more important of the events. I expect the RBA, and ECB to remain hawkish with their intentions to fight inflation, while the BOE and RBNZ are grasping at straws.

The ECB has to deal with the fastest inflation in its 10-year history… That’s not a good thing folks… Not for a Central Bank, whose mandate is to provide price stability. The economy may be cooling, which I’ll talk about in a minute, but inflation is rising – which means rates remain at current levels, or may even go higher as the summer days get hotter.

With the return to risk aversion overnight, the Japanese yen (JPY) has rebounded along with Swiss francs (CHF). It will be interesting to see if the risk aversion can set its teeth into all the “euphoria” surrounding the U.S. markets these days.

The Eurozone economy seems to be slowing down, which shouldn’t come as a surprise. I’ve said all along to expect a slowing of the economy… But not a complete shut-down/recession, and this “slowing” might just be what’s weighing on the euro these days. There’s an important thing to remember about the euro… It’s the “offset” currency to the dollar. So… Look at the two currencies… The dollar, with all the awful fundamentals, a recession, low yields, a war, etc. and then the euro, with a slowing economy… Eventually, the markets will return to the underlying trend.

But first, we might have to endure some euro weakness. But, remember, the dollar has all the bad fundamentals… Sort of like a gauntlet to get through… And while it’s getting beaten, the offset currency is likely to be in favor.

OK… A reader sent me a note about the one-year auction of Treasury Bills, and said, “This is scary isn’t it?” OK… Here’s the skinny on that… You see U.S. Treasury Secretary Paulson is feeling like he’s been “through the desert on a horse with no name” these days. The Treasury is going to issue one-year T-Bills tomorrow for the first time since 2001. With the expanding budget deficit, they have no other choice. The cheese that binds here is the fact that Paulson is indicating that the Fed Reserve, who in the past, had been a regular purchaser of the debt, may not be willing to do so… You see, the Fed is focusing on taking on all that bad debt from mortgage lenders… (Can you say, “The Fed’s focus is all screwed up?”… I knew you could!)

Want some proof that our deficit situation has become completely out of control… How about this little ditty… In the first five months of 2008, the Treasury sold $1.4 trillion of bills, an increase of 36% from the same period last year. Oh, but don’t let that get in the dollar bulls’ way of buying dollars! Deficits don’t matter, right? HOGWASH! You and I know that! But these guys running the country don’t believe it… And that’s a real shame, or sham… Pick one, either one applies!

OK… I have to spend a minute talking about the announced investigation of the CFTC (Commodities Futures). A lot of people believe the investigation will reveal some bad stuff being done to push up the price of oil… Now, I’m not going to sit here and pretend to believe there’s nothing to that… But come on! If the authorities really thought they were going to find something noteworthy, do you think they would announce to the public they were going to investigate? Wouldn’t you want to sneak around and zip the lips until you had the thieves?

I think that this has more “calm the nerves of the public” to it, than it has “to catch a thief”. I mean, come one, we don’t build refineries; we don’t drill where we KNOW there is oil; we haven’t done a darn thing about alternative fuel, despite knowing that we’ve needed to do something since 1973; and we drive gas guzzling cars… But wouldn’t it be better to “blame” someone else for the fact that gas is $4 a gallon? Let’s go after the commodities guys… There’s got to be something there!

It’s supply and demand folks… We have two large countries with billions of people that now demand oil that never really had a demand before… China and India… Take that supply and demand, and mix in a falling dollar, and you have high oil prices.

OK… Today, the data cupboard will show us the color of the ISM Manufacturing Index. You may recall this index has been holding out below the line in the sand of 50, which indicates contraction or expansion, for the past four months. The experts believe the index will have inched up to 48.5 in May – still below 50 – and that should weigh on the dollar a bit today.

We’ll have some other minor reports as the week goes on, leading into the Friday Jobs Jamboree… But I’ll talk more about the Jobs Jamboree as we get nearer to Friday.

The Aussie dollar (AUD), which has been the belle of the ball lately, showed some pimples this morning, after a report showed that retail sales in Australia had unexpectedly declined. I wouldn’t let my shorts get all bunched up over this. As I always say… One swallow does not make a summer… And this is the first “soft” economic report we’ve seen from the land down under. I don’t think we’ll see the RBA back off the rate hikes either!

Currencies today 6/2/08: A$ .9555, kiwi .7850, C$ 1.0045, euro 1.5550, sterling 1.9625, Swiss .96, ISK 75, rand 7.7175, krone 5.12, SEK 6.0175, forint 155.33, zloty 2.1750, koruna 16.15, yen 104.90, baht 32.58, sing 1.3630, HKD 7.8040, INR 42.35, China 6.9325, pesos 10.33, BRL 1.6240, dollar index 72.97, Oil $125.81, Silver $16.86, and Gold… $892.10

That’s it for today… My long time friend and colleague, Chris Gaffney, traveled to San Diego with his lovely family this past weekend to run in a marathon there. I marvel at his determination to do these marathons. Yesterday was darling daughter Dawn’s husband, Jerry’s birthday. We all celebrated at little buddy Alex’s baseball game! Alex just finished four games in five days… That’s crazy! Congratulations to Alex, as he just finished 6th grade! School’s out for Summer! School’s out for ever! OK, enough Alice Cooper for a Monday morning! Kristin’s back from Cancun today! It will be interesting to get her take of the conference! OK… Enough! Time to go! I hope you have a Marvelous Monday!

P.S. To get The Daily Reckoning sent directly to your inbox, sign up for our free email newsletter, or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Source: Reigniting Fears