We have the banks. You’ll remember from the first series that they’re the ones who parcelled up a load of mortgages and then sold them on… with less-than-hilarious consequences.

We have the credit ratings agencies. Their role last time round was to give dodgy debt an AAA rating, so that someone would buy it when the banks sold it on.

But one cast member — the market — has refused to take part in the new project. So the central bank will play that role instead.

On January 23 this year, my colleague Garry White wrote: “Last year was the year that investment bankers proved to the world that they are not as clever as they think they are. Will this year be the year when central bankers prove the same?”

It looks like it could be. On April 21 the Bank of England unveiled its special liquidity scheme (SLS). The idea was to provide £50 billion of funding to UK banks. They could access this funding by swapping mortgage-backed securities for government bonds. They could then use these bonds as collateral to borrow funds.

There has been some speculation that the banks would shun the scheme. There was a fear that any bank using the scheme would be stigmatised as unable to borrow elsewhere. And besides, the borrowing fees are high.

The Bank of England got round the first problem by guaranteeing that any loans would be made in secret. If you request the names of borrowing banks under the Freedom of Information Act, your request will be denied.

The second problem was tackled, quite simply, through a marketing drive. The Bank encouraged lenders to use the scheme, and dropped the hint that they would be prepared to breach the £50 billion limit.

That hint has been picked up by the banks. Far from being shunned, the SLS is expected to be oversubscribed. Lenders are looking to swap up to £90 billion of mortgage-backed securities for government bonds.

But here’s the rub. The Bank of England is taking onto its balance sheet assets for which there is currently no market appetite. These are rated AAA (a necessary requirement of the SLS), but they’re rated by the same agencies that gave that rating to assets that were anything but.

Ultimately, there’s a risk involved in all this. We don’t know how big a risk, but there is one thing we can be sure of — taxpayers’ money is underwriting it.

You and I are being dragged unwittingly into the next phase of the credit crunch.

“It’s all the same clowns doing all the same tricks,” says colleague Frank Hemsley, Fleet Street’s resident angry man. “It’s a bloody circus — and we’re being forced to buy a ticket!”

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Yves Mersch, a member of the ECB’s governing council, says it is “looking very hard at whether there is not a specific deterioration of collateral” that the ECB is accepting in return for funds.

Indeed, there are suspicions that some banks are deliberately creating assets to swap for ECB Treasury bills. This shouldn’t surprise us. Banks are staffed full of ingenious people who’ll try any trick or wheeze to make a few quid.

The irksome thing now, though, is that ‘few quid’ could end up coming out of our pockets.

Gold vs Oil — what’s the best inflation hedge?

There’s a debate raging in the FT today about the best way to hedge against inflation. Traditionalists say gold, but the yellow metal has slipped lately.

Meanwhile oil, which like gold is denominated in dollars, has surged ahead. Oil investors have done better in recent weeks than those holding gold.

“But why do we have to choose?” asks Garry White. “I say we can have our cake AND eat it.”

(As an aside, let me assure you our commodities editor knows all about having his cake and eating it. I still remember the time Garry made a beeline for a plate of éclairs I brought into the office).

As Garry explains in his article today, a sensible investor doesn’t get side-tracked by artificial debates. He remains focused on the long-term goal — growing his capital and protecting his wealth from inflation.

Gold and oil both allow you to do this. Let Garry show you how.

A smarter way to play the energy boom

If you think Britain’s population is growing too fast, be thankful you don’t live in Qatar. There the number of people is growing six times faster than in the UK.

What’s behind this population surge? A booming economy.

And what’s driving Qatar’s boom? Gas!

Liquefied natural gas, to be precise.

“Every serious investor needs to be in the Gulf right now,” says our special situations man Manraaj Singh. “They’ve got the growth, they’ve got the resources… this is a real investment no-brainer!”

Qatar is not alone. The whole region is taking off. But you only have a few days to get in on Manraaj’s Number One Gulf Investment.

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Editor

Source: Credit Crunch 2, This Time it’s ‘Your’ Money

Bankers rejoiced. Finally, they could shift the festering lumps polluting their balance sheets and move on. Crucially, the estimated £50bn measure leaves the risk with the banks and not the UK taxpayer via the Bank of England. The fall in the interbank lending rate suggests it has done something. The benchmark three-month Libor is now 5.88%, edging down from a high of 6% earlier in the month.

How bad a bind are UK banks in? The big four – RBS, Barclays, HBOS and Lloyds TSB – are short £37bn, calculates JP Morgan. And on Tuesday RBS announced itself as the first to go cap in hand to shareholders for £12bn. Others are expected to do the same, though Barclays later denied any such plans.

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Tight food supplies continue to make the news in the developing world and the World Bank warns of potential unrest in 33 countries as a consequence. Reports of rationing in the US continue, with even the likes of US retail giant Walmart restricting some food purchases and Costco considering a similar measure.

Ironically, one of the world’s bread baskets, Argentina, is suffering food shortages after farmers responded to a new export tax by blockading roads and restricting supply. The ongoing dispute claimed its first casualty on Friday when its Economy Minister, Martin Lousteau, quit.

In Japan $116 oil and dearer food may have actually killed off a decade long problem – deflation. Its core CPI inflation leapt to 1.2% and panicked investors fled the bond market.

In the equity markets, stocks look to be end the week on a firmer note. London’s FTSE recaptured the 6,000 level on Friday at 6,083. The Dow is at 12,848 in mid-Friday afternoon trade and gold has pulled back to $883. Oil, having hit $120 has shed around $5 as the dollar has strengthened.

Finally, there is no sermon again this week as Peter continues his well-earned break. He will be back next week.

Enjoy your week-end.

Regards,

Rob Mackrill
The Daily Reckoning

Because unfortunately for George the elder, he did end up raising taxes. And even voters – who are a forgiving and undemanding bunch a lot of the time, given the way that politicians generally mess them about – wouldn’t stand for such a blatant U-turn, especially when it meant money coming directly out of their pockets.

None of the UK’s banking chief executives have actually said: “read my lips – no big rights issues” in so many words. But after merrily hiking dividends and generally strutting around like the credit crunch was water off a duck’s back, they might as well have.

Yet now – according to press reports – it seems that the Royal Bank of Scotland is about to go to shareholders, cap in hand. Shareholders – like voters – are also a pretty passive bunch a lot of the time.

But they might be demanding some heads on plates in return for their cash on this occasion…

RBS close to launching a rights issue

Royal Bank of Scotland (RBS) is apparently set to raise between £5bn and £12bn in a rights issue. The bank hasn’t commented yet, but we’ll be getting the full details next week at the interim trading statement.

Before anyone starts worrying about their savings, remember that as Justin Urqhart Stewart tells the BBC, “this is not a customer issue, it’s a shareholder issue”.

Basically, the bank needs to raise more money to give itself a bit of breathing room. RBS is one of the most ‘thinly capitalised major lenders’ in Europe, as Richard Fletcher puts it in The Telegraph. It has an equity tier one ratio of just 4.25% (the UK average is 5.5%, and it shouldn’t drop below 4%). Banks need to keep a “certain cushion of cash relative to the amount of risk on their balance sheet”, as Alex Potter of Collins Stewart explains to the BBC. The reason that RBS’s is so small, is mainly down to its takeover of Dutch group ABN Amro last year – a fight which Barclays must be thanking its lucky stars it lost.

The timing is perhaps the most interesting thing. Reports of the capital raising comes after Gordon Brown’s big meeting with the banks earlier this week. The Government is trying to get the mortgage markets moving again – voters don’t like falling house prices, after all – and it seems that in return for pumping more money into the markets, it expects banks to start clearing the air around their opaque balance sheets.

Other banks are likely to follow suit

RBS is extremely unlikely to be the last bank to have to raise further capital. The Telegraph quotes one ‘senior banker’ as saying: “Almost every British bank is going to be thinking about a rights issue at the moment and the next three to four weeks will be crucial.” The good news for the other banks is that once RBS has blazed the trail and taken the initial wave of criticism, the way will be open for them to follow suit.

The reality is that up until now, banks have been scared to admit to any problems – and they may have had a point. The massive slump in HBoS’s share price last month on the flimsiest of rumours showed just how ready investors were to panic.

If one of the smaller, more widely-scrutinised former building societies had been the first to announce a rights issue, there may well have been a much more dramatic reaction – people are still primed for another Northern Rock going off.

But the meeting with Brown has given them an excuse. And RBS is also a much more stable bank in the public perception – the chances of people misinterpreting headlines about fund raisings and forming a queue outside their nearest branch of RBS are pretty low.

Is this the beginning of the end of the credit crunch?

And indeed, the stock market this morning has actually sent RBS’s shares higher. Normally you’d expect them to fall – after all, a rights issue means more shares, which means existing shareholders are diluted. But clearly investors hope that this is the beginning of the end of the credit crunch – now that RBS has broken the ice, banks will start to bite the bullet, and things might start to improve.

It’s a nice thought. But even if this marks the beginning of a clear-out, there’s a long way to go. The US banks started this process a while ago, and they’re still coming up with regular writedowns. Yesterday Merrill Lynch said it was open to raising more funds, after writing down another $9.7bn in its first quarter, even though it said it didn’t need more money just a fortnight ago.

And along with the writedowns, chief executive John Thain warned that he was “concerned about the risk of the market problems seeping into the real economy.” Where’s he been for the past year, I wonder? The ‘real economy’ in the US is now almost certainly in recession.

And it’s only going to get worse, both there and over here. As the writedowns keep rising, so do the job losses. The Telegraph reports that London is likely to see more than 3,500 City job losses announced today. “Recruitment experts said the scale of the job losses was the worst since the dark days of the 1991 recession.”

Source:http://www.moneyweek.com/file/45614/are-uk-banks-starting-to-face-up-to-the-credit-crunch.html

More are likely to follow, at least until normal conditions are resumed. Unclogging the mortgage market would be numero uno on an estate agent’s wish list. Something the Bank of England is working on. They’re look for a way to squirt more cash into the system without adding to the £100bn gorilla dropped on to the taxpayer’s already aching back with Northern Rock.

The Treasury is about to OK a plan for banks and building societies to swap their mortgage-backed assets for government bonds as opposed to cash, reports The Times. Though they don’t say why, but I think we can guess. The BoE can get its treasury bonds back more easily than slippery cash. It’s essential the taxpayer doesn’t shoulder any more risk, says LibDem Treasury spokesman, Vince Cable. Agreed. Otherwise we might as well give old Wedgie Benn a call, nationalise the lot of them and be done with it. Just when we thought we were Thatcher’s spawn, a Socialist utopia muscles in through the back door and repossesses our mortgaged home in the name of the Council.

A deal with the UK banks is pending within the fortnight and London bank shares are having a good day on the back of it. What also came to light today is that Libor, the measured rate at which banks lend to one another, may not be giving an accurate read. Commercial banks may be being a little “economical with the actualite”, say reports, of exactly what they’re having to pay for funding. The fear is that if everyone knew just how bad it was, it wouldn’t help much, not least them. The British Bankers Association is so concerned it has brought forward its review of the Libor rate system in a bid to shore up its credibility.

Over in the US, “real estate is getting worse,” JP Morgan CEO Jamie Dimon told investors yesterday. He expects US house prices to fall by another 9% this year. Others see peak-to-trough falls of around 20% or more.

Another banker, CEO of Wachovia Kennedy Thompson, doesn’t see the economy recovering until late 2009. “Until housing prices find a bottom, capital markets are going to be frozen.” His counterpart at the Bank of America, Kenneth Lewis, would appear to agree. He doesn’t see the US housing bust bottoming before 2009 either.

Former Fed chief Alan “it’s not my fault” Greenspan said this thing won’t be over until the housing market stabilises, but is a little more optimistic that it will come sooner. When that day comes what percentage of the economy will be consumer spending we wonder? It was around 70% before the roof collapsed on the EZ money house-as-a-cash-dispenser economy.

Much the same could be said of the UK’s economy too. Consumers, either voluntarily or involuntarily, have been pulling in their purse strings and refocusing on needs at the expense of wants. The implications of this collective behaviour shift have been showing up regularly in the results of publicly listed companies, most notably in the retail sector. New examples today include WH Smith, where like-for-like sales fell 2% on high street “weakness”. And Findel plc, a shopping catalogue business and educational supplier, which issued a profits warning as it upped its bad debt provision. Something of a swift change of fortune after saying earlier in the month it expects a record profit for the year to March.

*** Woah…oil $115!

It keeps going up in leaps and bounds, but Mr Market doesn’t seem to care. His attentions appear focused exclusively on another form of liquidity. The kind that generally is found above ground and sloshes (or did, pre-August ‘07) through financial markets, ensuring everyone it touches is kept in champagne and bonuses.

And yet a few days ago we had the Russian VP of oil giant Lukoil saying Russia had hit peak oil already… Already? And there we were thinking the natural home of autocratic rule was just getting started with the black goo!

And today, the FT does nothing to calm the nerves of a tight market. Nigerian production could fall by a third by 2015, it reports. Reading further we find this is less a supply issue than a financial one. Big Oil, in the shape of Shell, ExxonMobil and Chevron, are finding an unreliable partner in the Nigerian government (why are we not surprised?) which is not ponying up its share. A headache Big Oil one doesn’t need, particularly Shell, given its recent history of the dodgy reserve booking and its ongoing struggle to replace what it’s sucking out of the ground with new reserves.

*** “Don’t talk to me. You want to know why Poles going home? I tell you,” says Simon, who’s been fixing up the bathroom and is returning home (for a visit he assures).

“I come here four years ago. Then 7 to 1”, (7 Polish Zloty to £1).

“Now 4 to 1 and every day going down.”

A trend noticed by “counter eddy” migrant Jim Parton, who thinks there may be money in it. The former City Whiz kid and author of the bestseller Buck Stops Here, is now installed in a Polish castle and asks: where can one buy Polish bonds? A nice 6% yield, an appreciating currency and wage inflation being crushed by migrant workers returning home. Sounds good to us, and with little call on our testosterone levels.

Finally, as basic food supplies cause shortages and price rises around the world, check this “World Clock” for a sobering estimate of how fast we’re adding to our number.

Finally, finally… no news from Bill again today as the concerns of running a multinational publishing empire make for increased demands on his time. He will be back soon, I’m sure. As to when, I’m not.

Regards,

Rob Mackrill
The Daily Reckoning