Probably not. But what if they offered you some sort of collateral, which you could sell if the loan turned bad? Well, maybe… but not if that collateral could soon be worth less than what you’ve lent to them.

This is the proposition lenders face at the moment. The economy is weak; recession looks more and more likely. We have an over-inflated housing market, meaning house price risk is firmly to the downside.

So is it any wonder that the British Bankers’ Association (BBA) today reports a 46% year-on-year fall in the number of mortgages being approved? Yes, banks have been burned by the credit crunch. But there are more fundamental reasons why it’s just not in their interests to do a lot of lending right now.

Everyone’s terrified of a housing crash. But I think a slowdown in consumption will be what tips us over the edge (afterwards, of course, we could well see the dreaded house price meltdown). Nearly half of all mortgages aren’t to buy new houses. They’re remortgages, and the BBA says they’ve been hit too.

Remortgaging allows those fortunate enough to own an expensive house to turn their equity into ready cash. For years now people have been, in effect, hitting the shops and spending their houses.

But now we’re wising up. That equity could soon be diminished — better not blow it all, then. Especially not if you might lose your job.

As lenders and consumers draw in their horns, expect to see spending slow. So far official figures have defied this logic. But today, perhaps we’re seeing the first cracks in the dam.

The Office for National Statistics today reports retail sales volumes fell 0.4% between February and March. That’s not a huge amount, but it may be the start of something rather unpleasant.

The fact remains that Brown’s claims of being ‘good at the economy’ were based on a credit-fuelled consumer binge. A child could tell you that you can’t live beyond your means forever.

Now a correction is inevitable. Everyone seems to realise this — everyone, it seems, except the government. Brown and Darling are still insisting it’s the fault of those stingy lenders. ’If only they’d give people more money, everything will all be OK!’

This is buck-passing — and it won’t wash. Boom and bust never went away, despite what our leaders may once have claimed to the contrary.

Yet they were happy, as politicians always are, to bask in the false glory of the good times. Of course, no one forced consumers to borrow what they couldn’t afford, nor lenders to lend it to them. But the Government was more than happy to encourage such unsustainable behaviour — it had elections to win!

Now, all those claims of economic genius have come back to bite our glorious leaders, and they’re desperately running for cover. What a shameful spectacle!

Manraaj’s late-night caller…

Manraaj Singh, our emerging markets man, looked bleary-eyed this morning.

“I got woken up by a phone call at 3am,” he said.

Normally this would make Manraaj livid. He’s a man who works hard, and sleeps harder. But last night’s phone call made his day (or, rather, the middle of his night).

“This is the breakthrough we’ve been waiting for,” he said. “The tide has turned in Asia!”

Manraaj reckons Asian markets have been unfairly tarred with the western credit crisis brush. But that could now be about to change…

“Once sentiment turns… pow! Asian markets will bounce right back where they belong. And we’re going to ride that wave!”

So why is Manraaj so optimistic? It’s all to do with a desperate move the Chinese government has just made.

An apology to business people everywhere

“How dare you say that politicians run the country as they would a business,” writes one reader in response to yesterday’s email. “I’ve been in business since the late forties, and this lot especially couldn’t run a whelk stall on a cash basis!”

I have to admit, he’s got me bang to rights!

I was writing about Brown’s now infamous U-turn yesterday. The Government now proposes to rebate all those made worse-off by the scrapping of the 10p tax rate. But, of course, they’ll have to wait for their money — not an ideal solution for the cash-strapped.

I said that politicians “treat society the way they’d run a business — as long as all the numbers add up at the end of the year, it’s all OK”.

I stand by my belief that they’re out of touch with the people they claim to help. But I realise that my comments were a massive slur on the business community!

I know I’d take umbrage at being compared to the Brown Brigade. So I’d like to issue a full and unreserved apology to business people everywhere.

When it comes to our glorious leaders, the only fair comparison is with other politicians…

Until tomorrow,

Ben Traynor

It seems some banks are giving phony LIBOR quotations that don’t reflect the true rates at which they accept deposits. In the perfect financial system, beloved of regulators and academics, this kind of discrepancy shouldn’t happen.

In the real world it does, and I’ll explain why.

The LIBOR system was set up in the 1960s, when the market for dollar-denominated bank deposits outside the United States grew big enough to worry about. On a daily basis, the British Bankers Association would go to 16 banks, which were thought to be top quality, and ask those banks at what rate deposits were being offered. Assuming an honest reply, the data would be compiled to determine the average rates at which deposits were offered to prime banks. The average of the 16 banks becomes that day’s LIBOR – for 1-month, 3-month, 6-month or other period deposits.

Should be a foolproof system, right?

Not quite. To see what can go wrong, let me share a little personal story. Ten years ago, when I was working in Zagreb, Croatia, I advised on the establishment of a LIBOR-type market between Croatian banks for 1- and 3-month deposits in Croatian kuna. We called it the “ZIBOR” market. Realizing that very few Croatian banks were solid credit risks at that time, I suggested that the bankers’ association restrict the system to no more than the three top banks.

Naturally, since I was only the advisor, they ignored me and let in all the large members of the association – seven in all.

The system worked fine for a time, but then a credit crisis struck. NATO got upset about Kosovo and started bombing the neighborhood. Only occasionally did bombs accidentally fall on Croatia, but the bombing played merry hell with Croatia’s tourist business. The result was a liquidity crisis in Croatia, and big trouble in the ZIBOR market.

I heard some grumblings that ZIBOR had become unrealistic and been investigated. There were two problems:

• First, one of the ZIBOR banks, Splitska Banka, was in such horrendous shape that no other bank would offer it deposits at all – not at any rate. Splitska was naturally interested in continuing to participate in the immense honor of the daily ZIBOR fixing, so its dealers would insist on going last. They would ask what the other banks had quoted, and then quote the average. Perfectly sensible solution, as I told everybody, provided none of the other banks took to doing it – it just meant there were only 6 banks really quoting ZIBOR, but six was still plenty.

• The second problem occurred as liquidity got worse, and consisted of banks complaining that they were actually being asked to place deposits. Other banks would ring them up and ask them to place deposits at ZIBOR. They complained that this was impossible, since most days, they hadn’t any money. Admittedly, the ZIBOR “reference amount” (the amount for which the quotation was supposed to be good) was only 100,000 kuna, or about $15,000. But some days even that amount was difficult to find. They wanted to reduce the reference amount to 10,000 kuna ($1,500), presumably so that if they were asked to place a deposit, the bank’s chief executive officer could conceivably raise the money on his credit card!

So much for emerging-markets banking. When I returned to the United States in 2000, I thought I had left all that behind me. Apparently not!

Banks are now apparently making fake LIBOR quotes on the grounds that they don’t want to be thought of as a credit risk, from which other banks would then demand a premium. Just like the old days in Zagreb!

But given the subprime mess, some large banks are rather dodgy credit risks, and they should be paying a modest premium for their deposits. In the 1974 credit crunch, some perfectly respectable Japanese banks paid a premium of as much as 2% for their short-term dollar deposits.

In these volatile markets, any whisper of trouble over a bank makes other banks’ dealers not want to place money with them. Their feeling is that there’s no point in getting fired for doing business with another bank that goes bust, especially as you’d probably be losing your job at the bottom of a bear market, when times are tough. So it’s not surprising that the LIBOR system is wobbling a bit.

Despite its troubled history, Croatia’s ZIBOR has survived to this day. And it’s likely that LIBOR will do the same. However, there needs to be some realistic threat of banks being banned from participating in the LIBOR system if they provide false quotes. There also needs to be some realization that, in a tight market, not all banks will borrow at the same rate.

The real problem is the hundreds of trillions of dollars of derivatives contracts that use LIBOR – $382.3 trillion in interest rate swaps alone at the end of 2007, according to the International Swaps and Derivatives Association Inc. Just a 0.10% error on a six-month deposit, quoting 2.75% when the rate is really 2.85%, may not sound like much, but if it’s repeated over $382.3 trillion in LIBOR quotes for interest-rate-swap contracts it comes to a fair piece of change. A lot of change. To be precise, we’re talking about $194.3 billion.

Now that’s what I call an accounting error.

It looks to me like it’s a major problem. But it’s one the world will just have to live with.

And there seem to be a lot of those kinds of problems, right now.

The Bank expects lenders to continue reducing the number of loans available well into the summer. Higher deposits will be needed, while the Bank also expects more borrowers to default.

Meanwhile the Co-operative Bank, whose profits have taken a £26 million hit due to write-downs, has pulled all of its two-year fixed rate deals.

Mervyn King, the Bank’s governor, is now under more pressure to cut the interest rate next week. Will he do it?

I took a straw poll in this morning’s editorial meeting. I was slightly disappointed at the consensus view: a quarter-point cut. That seems to be the prevailing attitude in the markets too.

I can’t shake this nagging feeling I have that Merv might take the opportunity to wrong-foot everyone and leave rates on hold. Call it a hunch. Leading expectations is his job, not following them. Maybe he’ll take the opportunity to look tough on inflation?

“But there’s a time and a place to be a stick-in-the-mud,” counters Theo Casey, my stock-picking comrade-in-arms. “The middle of a credit crunch isn’t it.”

Maybe he’s right. Maybe the market too, which has priced in a 70% plus chance of a quarter-point cut, is right (or 70% right). And sometimes it’s better to be right than to be different (though a quarter-point cut makes no difference to my long-run economic prognosis).

But still… that nagging hunch just won’t go away.

Away from the Threadneedle Street, and the Treasury has covered itself in… what’s the opposite of glory?It looks like it may be preparing to back down over “non doms” — foreign residents in Britain who pay less tax by claiming non-domiciled status. In a letter to the British Bankers’ Association it says it is “looking urgently at this issue with a view to addressing it through necessary amendments to the Finance Bill”.

“The non-doms have thrown their expensive toys out of their expensive prams,” says my colleague Frank Hemsley. “They’ve threatened to take their money and their business elsewhere — which is what everyone said would happen. And the government has panicked. They look like fools now.”

Indeed. Of course, it’s patently unfair that super-rich UK residents pay less tax than the rest of us when both they and we earn out money here. But by trying to be champion of fairness, the government could well have underestimated the economic implications.

It could be too late to repair the damage. Even if they scrap the £30,000 levy, many non-doms feel slighted, and worry the UK climate is turning unfavourable. What’s certain is that the benefits the government hoped to reap — looking strong on an emotionally divisive issue — will evaporate if they back track.

Frank’s right. They look like fools.

Has everything bottomed?

Bill Bonner, my sparring-partner on matters American, has a fixation with bottoms today:

“Look around you; you’ll see bottoms everywhere,” he says. “Yesterday, prices on just about everything were rebounding,” he adds, making this piece feel once again like a financial newsletter, and slightly less like a Carry On film.

“The euro rebounded against the dollar. Asian markets rose. Wheat, soy, rice prices — they’re all on the way back up. And the Commodities Research Bureau index – that rose too.”

So… is this the end of the crisis?

George Soros is predicting a few good weeks, but reckons we shouldn’t get complacent.

“We had a good bottom,” said Soros in an interview yesterday. But Soros believes the rally will last six weeks to three months, before reversing. “This will probably not prove to be the final bottom,” he said.

By the way, Soros is hawking his new book at the moment. He’s really no better than those ‘glamour’ models-turned authors Jordan, Abi Clancy and Alan Greenspan, is he?

The biofuels collapse has just begun

The Germans have pleased Garry White today. Our commodities expert is a long-standing opponent of biofuels, see. The German government has shelved plans to increase the compulsory ratio of bioethanol in petrol to 10% next year (the current level is 5%).

“Stay away from the biofuels sector,” warns Garry. “They are not as green as everyone thinks, and they are not a good investment. The risks are skewed to the downside.”

Western uncertainty is good news for Manraaj Singh

Another who suspects we’re seeing false bottoms at the moment is Manraaj Singh, our emerging markets wizard. Manraaj reckons there’s plenty of trouble ahead in western markets… and frankly, he’s delighted at the prospect!

“Uncertainty in western markets will speed up the flight of capital into emerging markets,” he says. “Remember, money always follows growth. Right now, the only real economic growth we’re seeing is in the emerging markets.”

Readers of Manraaj’s Profit Hunter service have great exposure to some of the world’s hottest-looking markets. He’s keeping his eagle-eye on the global markets… and I’ll be keeping you bang up-to-speed with his intrepid research.

Have a great weekend!

Until Monday

Ben Traynor