The wonder of financial crises is how events can move straight from impossible
to inevitable, without ever passing through improbable.
Two weeks ago nobody would have imagined that, before the end of the month,
the Bush Administration would have nationalised the world's biggest
insurance company, that two of the four biggest global investment banks
would be out of business and that the US Government would take
responsibility for three quarters of the country's new mortgage loans.
Sadly, the events of the past two weeks may be only the prelude, not the
climax, of this amazing crisis. Even the apparent rescue of Halifax Bank of
Scotland may result in a bigger crisis, if the drowning HBOS drags down its
rescuer, Lloyds TSB. If this happens, every big bank in Britain, except
possibly HSBC, will have to be nationalised, Northern Rock-style.
The same would become inevitable in the US if market speculators who have been
richly rewarded by the US Government for taking down Fannie Mae, Lehman
Brothers and AIG, turn their attention to the next group of stumbling
financial institutions in the firing line: Washington Mutual, Wachovia, Bank
of America, Morgan Stanley and Citibank. If any of these wounded giants
collapses, the others will fall like dominoes and the entire US financial
system will have to be nationalised. In a financial crisis, the impossible
can become inevitable in one day, as we saw in Britain on Black Wednesday.
But the operative word here is “can”. To understand what could still be done
to prevent this crisis turning into a true disaster, we must look
dispassionately at the unintended consequences on the markets of recent
government actions. This means moving away from the moralistic slogans about
“greed” or “bailing out reckless bankers”.
The main response to this crisis has been a furious argument over who allowed
the banks to get into this mess in the first place and how such imprudence
could be stopped. This is analogous to the heated debate among French
politicians, as German Panzers rolled into Paris, over who had the stupid
idea of building the Maginot Line. There will be a time for apportioning
blame and inflicting punishments and reforming regulatory structures. But
right now the only question is how to avoid a catastrophe in the next few
weeks.
It is clear that most of the actions taken recently by regulators and
governments have exacerbated the crisis. Instead of using his Government's
unlimited financial firepower to defend the financial system, Henry Paulson,
the US Treasury Secretary, turned his guns on his own side, wiping out
long-term investors who tried to support leading financial institutions,
while rewarding speculators who tried to bring them down.
Mr Paulson was activating a financial Doomsday Machine, driven by a chain
reaction of actions by stock market speculators, regulators, credit-rating
agencies and accountants. The details of this mechanism are complex, but the
gist is simple - if a bank's share price falls below a critical level, its
credit is downgraded; it has to sell assets at fire-sale prices; this
further weakens its capital, leading regulators to question its solvency;
this drives down its share price and the vicious circle takes another turn.
What Mr Paulson did ten days ago was to hand to stock market speculators the
key to this Doomsday machine.
This may seem an outlandish accusation - especially against a supposed
financial mastermind who was a chairman of Goldman Sachs - but consider the
event that triggered the market attacks on Lehman Brothers, AIG and HBOS.
They all followed Mr Paulson's punitive decision on September 7 essentially
to expropriate the $20billion of capital injected into Fannie Mae and
Freddie Mac by shareholders over the previous 12 months. Long-term
shareholders made these investments, with the encouragement of the US
Government, to stabilise Fannie and Freddie. Meanwhile, a host of short-term
speculators were selling these same securities, convinced that the two
companies would be driven into bankruptcy.
By rewarding short-sellers while wiping out investors who reckoned on a
long-term recovery that would restore the mortgage giants to profitability,
Mr Paulson sent the clearest possible message to financial markets around
the world. Any investor who puts money into a US financial institution that
might run short of capital would have it expropriated by the US Government.
On the other hand, sellers of US bank and insurance shares would be richly
rewarded if they could destabilise any financial institution sufficiently to
force it to turn to the Government for help.
In the past few days the same pattern of perverse incentives has been repeated
in the bankruptcy of Lehman and the “rescue” of AIG. In both cases, Mr
Paulson decided to wipe out investors banking on a recovery while rewarding
destabilising short-sellers.
The key question is whether this scorched-earth strategy will become a firm
principle of Mr Paulson's responses to future attacks on US financial
institutions. The alternative view is that Mr Paulson may have cunningly
chosen the shareholders of Fannie, Lehman and AIG as sacrificial scapegoats,
to make a point about his harshness to “greedy bankers” - and that having
made this point, he will now be able to support more important institutions
such as Bank of America and Citibank if they come under attack.
Events in next few days will reveal whether cunning or incompetence is the
explanation for Mr Paulson's apparently self-defeating strategy, but in the
meantime, financial mayhem has shifted from New York to London - and with it
the responsibility for right and wrong policy responses.
As I write, the terms of the Lloyds-HBOS merger are unknown, but the key
criterion for judging its effectiveness is clear enough - and it is exactly
the opposite of the principle followed by Mr Paulson.
If the Lloyds-HBOS merger offers the enlarged bank some kind of firm
government safety net - not just for depositors, but crucially also for
shareholders - it will probably succeed and act as a firebreak against the
financial crisis on this side of the Atlantic. If, however, the merger is
presented as a “pure private sector solution”, with no government support
for shareholders, market attacks against HBOS will soon be revived and
redirected against the merged bank.
This will leave only one solution - nationalisation of the entire British
banking system. The impossible will suddenly become inevitable.
Spot on, Anatole. Perhaps the UK Gov't should now pay say £4 for each of its Northern Rock shares. This would not only be fair, but would also reimburse investors who were prepared to support the UK financial system and "punish" speculators who presumably still have short positions.
Tim Joslin, Cambridge,
When NR's MD can say 'there was nothing wrong with my business model', you know there is a grave, elephant-sized problem. We are in for a tough couple of years and even Anatole now knows it. Perhaps Brown may catch on soon, too. I bet Brussels is delighted the UK is not in the Euro!!
Colin, Malaga, Spain
Excellent article with many well made points. Given the past actions of the authorities (BoE, FSA, Government) I have become convinced our future is in the hands of idiots. The Lloyds/HBOS action offers a glimmer of hope as does the ban on short selling.
David, London,
The UK economy is based on being a centre of finance. We have little industry left, the oil is almost gone and the wheels are coming off the banks.
On a separate point, we and the US simply need to ban selling shares you don't own. The FSA has moved in the right direction.
clifford, Berkshire,
Privatise the profits, socialise the losses. I guess that is the new catch cry of American capitalists. The US taxpayer is paying the cost of the bail out. What will happen when tax revenues drop as a result of recession. This crisis has a long way to go.
Stephen O'Mara, Tamworth, Australia
Stop looking at tiny details, this is all for the one world bank/government/currency. It really is that simple.
The governments (elite banks) will own everything, it is just around the corner!
Just look at the bigger picture, the state of play today was
unthinkable yesterday, so what's next?
sheny, townless,
Isn't this just the end of the Kontratieff cycle?
The cycle the economists & governments & media don't want you to know about.
The inevitable mass depression at the end of a continuous 70 year boom/bust cycle, which will make all our savings worthless & push us all back into wage-slavery again.
joseph, middlesbrough, united kingdon
The UK Treasury made it clear a year ago that a) any bank Northern Rock size or up was Too Big to Fail, and b) they would not protect shareholders. So the UK has been in the position AK describes for some time. At least some US actors have a clue about markets - what price Brown/Darling's response?
Sterence, Oxford, UK
This could easily turn into the end of the world as we know it. I am sure Lloyds know what they are doing as they were the only bank to avoid buying others debt. Well done them. However Lloyds will enjoy one huge monopoly, especially as A&L will disappear. Banks will get a lot more expensive
Heeners, Bath,
The financial system is collapsing under the weight of its own absurdities. It is a grim time indeed for those who preach the righteousness of the market, while watching that market eat itself. This collapse is going to get worse, where we are going to be in a year is impossible for anyone to say
paul, Carlow, Ireland
We will certainly all be in trouble if the sharks push Lloyds-HBOS under....
Roger, Bertrange, Luxembourg
Make a crisis and go to war, its all happened before.
Governments won't or can't even be bovvered to find what
the size of the shortfall is.
Perhaps there are people banking on a crisis ?
M walker, Nr Bromsgrove, worcs
Where have you been A.K. these past 18 months?
David Barton, Truro, U.K
The American Dollar and British Pound are nothing more than printed paper from here on down.
The good news is that government debt will also become worthless as a new trading system is devised over the next decade or so.
Russia and the Middle East will have nothing but paper and oil to burn!
David Downes, Chester, UK
The answer is to outlaw short selling. Then the huge, negative, speculative, gambles cannot be turned into self forefilling prophecies.
R G James, Brasschaat, Belgium
Has Kalestsky got something against Lloyds, perhaps got stung by them? Sounds as though he wants this merger to fail.
cww, Ipswich,
I can well remember that the author of this piece criticised the Germans for having a manufacturing industry and also bemoaned the fact that they unlike the British were not flapping their credit cards and taking full advantage of the credit available to spend on household goods,houses etc.
george, Exeter, UK
But Anatole there is no crisis, remember all your previous columns? As for "nobody imagined" actually plenty did, including me. There is an underlying problem, that too much non-existant capital was lent too cheaply to people unlikely to repay. Banks did that and their shareholders are paying for it
Tim, London,
Anatole, you finally recognise there is a crisis. Blaming it on short sellers is an overly simplistic view.
Charles, Hong Kong,
Only one option.
A simple short term response - regulate short selling now for a defined period of time.
Whilst this would in thoery distort the market, would it be detrimental? The opposite of the upside is now proving as, if not more dangerously, destablising on the way back down.
Greed.
Dave, London,
Ordinary men (Thatchers children) have in effect no access to shorting. We've been pushed into stocks via ISA's, pensions etc and only been given the "long" option. We are told that in the medium+ term stocks always outperform other savings. Little do we understand that we've been set up big time.
Andy, Sheffield,
It's disingenuous to write that nobody could have foreseen that two of the four biggest investment banks would be out of business. A few weeks ago you were sneering at over-excited internet bloggers (I forget your exact phrase) for forecasting just such very events. Mike Shedlock for one.
Steve, Sutton,
Capitalism adopts rampant socialism in order to save itself! Who'd have thought it LOL!
Billy, Cardiff , Wales
It is the role of Government to run public services,not bail out Banks.
The only funds they have are our taxes which are already spent and borrowings.
They have no right to save Banks.
Market forces should prevail.
Nobody helps the little guy when he goes bang.
Rule book out of the window, sick
james allen, manchester, england
...humans certainly can make a mess of simply living. all this stress, anxiety, crises and calamity, its quite funny. i hope that this sobers people up to realising that most economics doesn't make any sense i.e. endless growth (where too?), greed (what for?), complex finances (how needless).
James, london, UK
i really dont see the problem with short sellers. if they where stable companies they wouldnt take the risk of betting on the shares to fall. i bet there arent any short sellers at work on hsbc or barclays are there, because those shares arent guaranteed to plummet!
will, grimsby, uk
These banks are now so big, they threaten the societies that they are part of. In the long term they must be split up.
Perhaps the government should act pre-emptively when a bank becomes a victim of shorting and buy up the discounted shares, thus forcing up the price and stabilising the bank.
JonB, Manchester, UK
A sound business with solid assets would not unravel so easily. All of this was sadly inevitable and unfortunately none of you would stand up when the 'loads of money' economy was being built.
It is now time for a Govt of National Unity to bring the economy back into balance.
Stephen Marchant, Newton Abbot, UK
The recent wisdom of Kaletsky:
August 25th:
"the big financial opportunities in the coming year will probably be on the upside."
September 1st:
"And despite all the headlines about a credit crunch, financial conditions are also relatively benign."
Top work.
Jake Sebastian Turner, Los Angeles, USA
No, no, no Anatole. Paulson is right. Short sellers reveal the fiction. They only make a profit if the shares are worth less. They will lose money with the Lloyds TSB takeover of HBOS cos someone is willing to buy HBOS shares. AIG & Lehman were worth zero; losses greater than capital. Live with it.
Alistair Nicholls, Manchester, UK
AK has finally woken up after peddling for years a nostrum of neo-liberal economics whose main objective has been to enslave most of the population in crucifying debt [secured and unsecured are the same nowadays]. Listen carefully AK: the sheep have woken up. House prices will halve.
Alexander Davidson, Crawley, UK
The only companies need to be nationalised are the energy (gas&electricity) companies. We don't need 10 utility companies making at least £1billion profit each. The banks will sort themselves out by buying and selling each other.
ray, london, uk
Its not just large Hedge funds that profit from shorting, may I suggest some of you guys jump onto speadbetting and make a quick buck out of these companies going bust. You wont believe how much can be made if a company goes bust at just £1 a point.
Neelkumar Patel, Peterborough, UK
Bill,
I fail to see why rewarding failure would end with renationalisation.
It's hardly like our Public Sector pay is performance-related
Rich, Sheffield,
Ban short-selling now - ban it immediately and ban it completely. We need to get back to a sensible way of running the stock market: if you like a company, buy and hold its shares. If you hold a company' shares and don't like it any more, sell. It should be as simple as that.
Ian Westbrook, Folkestone, UK
The banking sector is simply administration, and multiple duplication of that service from bank to bank. Nationalisation would eliminate this inefficiency and allow the government (thus society) to control the supply of money. Interest is then be redistributed rather than compounded into fewer hands
J WIlson, Glasgow, UK
The banking sector is simply administration, and multiple duplication of that service from bank to bank. Nationalisation would eliminate this inefficiency and allow the government (thus society) to control the supply of money. Interest is then redistributed rather than compounded into fewer hands.
J WIlson, Glasgow, UK
I'm surprised that no-one has drawn a parallel with Spain [USA] and Genoa [London] in the sixteenth/seventeenth centuries.
When Spain overextended, it converted its short-term debts into long-term ones, a series of credit crunches that destroyed its bankers. Genoa was the principal casualty.
Chris Dickinson, Brighton & Hove, UK
Rather strangely, no one seems at all perturbed by the speed of the takeover. Such takeovers are normally preceded by months of preparations.
Rick, Manchester,
Naked short selling (selling short without borrowing first) should be eliminated. "If you fail, you go to jail".
Banning short selling however, would hose the markets. A key piece of price discovery would vanish, the markets would become illiquid, and dud stocks would remain overpriced.
Cronan, London, UK
Matthew - I totally agree. Who are the idiots that are lending out stock to speculators, only to get it back at half the value? I must be missing something, because it seems just plain stupid to me.
Tony Pegg, Leicester, England
Where does this stop?! Now that we have allowed the Fed to take over any asset it wants, private property rights are meaningless. Where in the US Constitution does the US Govt get the power to do this? If they are going to nationalise failing companies, why not prosperous ones? Cheers, Comrade!
William Kent, Brandon, Canada
this bleating about short sellers and market attacks is nonsense. It is not possible to personify "the market" in this way. It is the consensus of opinion. If you sell short, its because you believe that the equity is over valued. If it's not, then buyers will appear. Let the market do its job
Dan, Henley, UK
Shareholders should not escape unscathed. They took risk and lost, up to now they have won big time. A bank's credit rating should be a function of its ability to manage its debt. So, stop short selling and change the rules on credit rating.
Neil Murphy, cromer,
What is being done violates the US Constitution and violates the Law. Wait ‘til the Lawsuits begin! Trillions of Dollars of lawsuits are coming like a tsunami that will wipe out any remaining wealth on Wall Street. America has now abandoned everything that made it rich in the first place. Cheers.
William Kent, Brandon, Canada
Shareholders should not escape unscathed. They took risk and lost, up to now they have won big time. A bank's credit rating should be a function of its ability to manage its debt. So, stop short selling and change the rules on credit rating.
Neil Murphy, cromer,
I thought Mr. Paulsen had now outlawed short-selling of banking shares. The UK Chancellor also needs to do the same for all shares for the forseable future. It is too big a temptation for speculators and serves no useful purpose to society.
Roger Corfield, Arusha, Tanzania.
The financial sector never created wealth - merely redistributed it.
Initially, it was the wealth of the colonies and dependencies that were pilfered. Latterly, it has been the savings of the middle and lower classes.
The UK does not need such a huge financial sector and the market is reasserting
Alfred, Portsmouth, UK
For an FTB with a big deposit it's safer to borrow and buy a property than have a stack of cash in the banks. Yes property will continue to go down but at least the asset is there and one can live in it.
Peter, London,
After Clementi, they could all be Solicitors now. So, roll on I will employ them all on Legal Aid rates of £65 per hour (to take all expenses of running an office, library, secretary, lighting heating insurance etc.) from. Best keep them away from the client account though! They may gamble it!
A Solicitor , South West , UK
Outlaw shorting. It defies logic that someone would lend an asset for the borrower to devalue that asset before returning it. Who is lending the stock - surely not the beneficial owners. Shorting is being abused through collective targeting whether proven or unproven. Stop it now.
Matthew, Bucks, UK
I don't understand why everybody keeps calling these consequences 'unintentional'.
Simon, Weymouth,
I firmly belive that shareholders should NOT be given any form of government protection. Anyone who buys shares is (or at least should) be aware of the fact that shareprices go up and down - and that they risk loosing all of the investment if the Co goes bust.
KJ, London,
If it is all nationalised, will we see an end to rewarding failure at the top level? The more that things change...
Bill, Wallasey, Wirral
And had Mr Paulsen not intervened.... what would have happened to the long-term investors' funds? A disincentive to the short-sellers? This is a necessary stop-valve for mercenary lending policies. The bigger (and more mercenary) they are, the bigger they fall.
Mike L, Chippenham,
lots of people are commenting on this. what is the rational for short selling? blind faith in "free markets"...??? this practice needs to be banned. financial markets are about overall social welfare, not feathering the nests of already wealthy bankers.
stephen, china, china
short selling is a normal market function. Those who call to ban it are the equivalent of market manipulators , simply unable to accept the fact that markets go down as well as up.. It takes all views to make a market.
Blame free market economics (ie the world we live in) not short sellers.
rikrok, London, uk.3
Lloyds have won because, along with HSBC, they had a better business model and were more prudently run than HBOS and some other banks. Good luck to them. It's just such a pity that so many hard-working staff have to suffer because the bosses goof up.
Frank Upton, Solihull,
There's no reason why Lloyds TSB shouldn't make a great success of the businesses they have just bought, and at a fraction of the price such a business would command in normal circumstances.
Lloyds have wisely avoided blowing away billions on what they dont know and stuck to what they do.
trev leigh, london, uk
Nationalise everything!
We are all Comrades now.
Paulson in charge is like putting the cat to guard the milk.
Cascading failures will continue the cascade on the other side of the Atlantic.
Cheers.
William Kent, Brandon, Canada
{pats Kaletsky on the back}
M, London, UK
And where is the money to come from to nationalise the British banking system? Remember, Gordon Brown has already flogged off the country's gold at fire-sale prices and thanks to his mismanagement over many years Britain has huge and mounting debts.
Adrian Gilbert, Tonbridge, Kent,
Reading this I was thinking "the only answer is to stop short selling" and then I reached the end of the article and saw that Ian in Tokyo had come to the same conclusion. Hedge funds are now the lunatics running the financial asylum.
Neil, Shanghai, China
Naturally if it comes to the nationalisation of the banks then the citizens will be fully entitled to nationalise all the industries they feel need to be nationalised , along with all aristocrat land and possessions, including the royals, who would then be homeless and in the dole queue. Rightly so.
Terry, Guildford, UK
I don't know whether you have noticed Anatole but the US Fed has now run out of money for bailouts. Do you really think the BoE and the Treasury have enough money to nationalise the entire British banking system? Dream on! The British tax payer underwriting mountains of toxic debt is also laughable.
Simon, London, UK
Maybe we need two new initially government backed institutions. First 'bigbank' with a role is to provide liquidity to solvent banks under speculative attack. Second 'biginsure' to, if necessary, protect these loans against the risk of default. The idea is outlined here: http://tinyurl.com/4v4vay
Stephen Stretton, Cambridge, UK
At last you get it, the house of cards is falling down. The last thing anyone should do in the future is listen to economists, fortune tellers have more common sense. Do some real research and disrobe the spivs, incompetent civil servants and politicians who are the creators of this mess.
Scott, Bangkok, Thailand
Sir: For years the major banks in the US and elsewhere have mispriced and miscalculated risks involved in compex securitized instruments in such a way as to allow executives and others who worked in these banks to line their pockets. The game is up,you've finally caught on, hence the shorts.
Peter Adam, Chevy Chase, MD USA
Is it terribly parochial of me, I a holder of Lloyds TBS shares, to hope the Cousins do a more shareholder friendly rescue than was done on this side of the Pond? :-)
One reason I purchased Llyods shares was it has been in business since 11 years before the Declaration of Independence.
Dave Livingston, El Paso County, Colorado, USA
Has anyone considered that a wholesale nationalisation of the British financial sector would not be that bad an idea to our great and glorious Socialist leaders? They've been wanting to do this for 100 years.
BaiDaLong, Brisbane,
Simple, ban short selling. It is obviously distorting the market and desperate times call for desperate measures.
ian, Tokyo, Japan
You fail to mention that Mr Paulson did exactly what you say he should have done to assist the private sale of Bearn Sterns and he asked the private sector if it would rescue AIG. It would not. So Mr Paulson hardly had a choice: he has gone for controlled liquidation of AIG, and they was no choice.
victor (off shore now thank goodness), Hamilton,
These investors are no different to suppliers who continue to trade with distressed companies. It's the risk of capitalism (the company is a separate legal entity). There's no runs on well managed institutions that didn't overextend themselves in areas they didn't understand due to ego and greed.
Joseph Wright, Seattle (expat), US
What is the mechanism that you think allows shorting the equity of a bank to undermine its business model?
David Boycott, London,
Mr Kaletsky finally notices the house is on fire. Who would have thought that things could come to this? Plenty, in fact dozens have sent him emails pointing out the obvious all year. Too many borrowed too much. Those who lent it now lose it. Now the Fed buys the mess it created, what a great idea.
Stephen Hargreaves, Hobart, Australia
What is the mechanism you are suggesting allows short-sellers of a bank's equity to bring down a bank's business model?
David Boycott, London,