November 11, 2007
We may not feel it in our pockets yet, but the US sub-prime crisis is coming to a bank near you.
The New York winter uniform of stifling high turtlenecks, outlandish earmuffs and quilted jackets is back. So too are the hundreds of Irish shoppers who will spend more than half a billion dollars in the city before Christmas. The city is bracing itself for the big spending season – but all is not well.
Up in the theatre district, where Conor McPherson’s brilliant play, The Seafarer, is previewing to packed houses, the glitz of showland is competing with the ticker tape of Wall Street for the attention of New York’s commuters. The news flooding in from the financial district is unambiguously deflating. New Yorkers, so tied up – via their 401k investments – in the stock markets, are worried. And why wouldn’t they be?
The banking crisis, which was supposed to be limited to the delinquent sub-prime market, is spreading rapidly – not just here in New York, but across the pond in London.
Last Friday morning, Barclays Bank – the third-biggest bank in Britain – saw its share price fall 10 per cent, following rumours of a $10 billion write-down on bad loans. (Barclays denied the rumour, but this follows the pattern of the past few months where the banks initially deny that there is a problem and then drip feed bad news to the markets, only to finally put their hands up and admit serious financial problems.)
Irish banks, already down some 40 per cent this year, have also seen their share prices hammered. Anglo Irish Bank, the darling of the property boom, is among those to have had share prices hit.
The credit crisis is moving from continent to continent, and the barriers between what most people are prepared to believe and the stark reality are narrowing steadily. In the past few days, banks around the world – even Swiss ones – have been queuing up to announce larger write-offs and increased losses from sub-prime debt instruments, in many cases before the ink has dried on the announcements of their original estimates of these losses.
More than anything, this rapid reversal has demolished the facade that the sub-prime disaster was a) small-scale, b) localised by industry sector and/or by geography, and c) something that would only affect earnings and share prices for, at most, a couple of quarters.
Instead, we have major institutions doubling and tripling their estimated losses – and firing their chief executives and other senior honchos. Let’s leave aside – for the moment at least – the absurdity inherent in this ritual whereby people who received huge pay packages because of their supposed managerial skills, but who failed in their jobs, are ‘awarded’ packages worth millions, often tens of millions – and for chief executives sometimes in excess of $100 million – when they are sent packing.
Usually, when a firm admits its stored-up losses and fires its boss, the markets react positively, reasoning that the boil has been lanced and the body will now recuperate.
But that is not the case now. Shares in the financial sector are being remorselessly pummelled because market players are absorbing the shattering realisation that there is not going to be a quick fix to the so-called ‘sub-prime crisis’ – because there is no such quick fix.
On the contrary: the estimates of total losses of $150-200 billion, which as recently as August were considered wildly pessimistic, are now mainstream. Since the first round of write-offs by the world’s (and especially America’s) biggest banks amounted to only $20 billion, and the second round may take us to the $50-70 billion level, it’s not hard to see why investors are now either in shock or in panic.
Against this background, it is hardly surprising that the unthinkable has become thinkable and then writable, and thus onto being the hot topic. Take Citibank: the question is not who the next chief executive or chairman might be, but whether the largest financial institution – also one of the biggest employers in the IFSC – will survive in its current shape.
The issue is not whether Citibank might go bust: hefty though its losses are, they are nowhere near that magnitude. What is being talked about in New York is whether it is possible, or even desirable, to allow this mega-institution to lumber on, or whether it would be better to break it up into the components from which it was assembled – investment banking, commercial banking, asset management etc.
Outlandish as this proposition might seem, this is what happens in credit crises. On the way up, banks buy each other, merging departments and activities. On the way down, the very gelling agent of the merger – profits – disappears, and the merged entity falls apart at the seams.
In New York, this process is taken for granted. If indeed, $150 billion in capital is going to be wiped out because of sub-prime losses – Nuriel Roubini, (www.rgemonitor.com) the number one global bear on this issue, now estimates $238 billion from sub-prime alone and double that from all sources – then many big names are going to be expunged entirely, shrunk severely or find themselves under new ownership.
In Ireland, we tend not to think this way because, up until now, banking crises have been bailed out by the state (AIB in the 1980s).This time around, if patterns in the US are anything to go by, Irish bank losses – in property alone – are likely to be enormous.
Investors have already sensed this; I’m not too sure that the rest of us have. But this has all happened before. In Norway and Finland in the early 1990s, the state had to raise government bonds equivalent to 10 per cent of GDP to bail out their banks. Could this happen here? Would it happen here?
Or might it be preferable to simply let the market do its thing? This would imply allowing share prices to fall more, making the banks attractive to a foreign takeover. A big shake-up in the Irish banking sector is the likely outcome of the credit crunch.
That is the easy part to understand, once you are prepared to think about it. But because these are banks – and as with their American counterparts, their loss of capital means they will be forced to lend less – the whole structure of the Irish economy, which has been built on ever-increasing amounts of debt, will be shaken to the core.
So far, the crowds of Irish shoppers — armed with their credit cards – streaming off the Aer Lingus planes at JFK are carrying on oblivious. But as Irish bank shares plummet, the realities of the global financial markets are only a shopping trip away.