Socialist Economic Bulletin has had a number of posts dealing with the economic errors in the government's policy to purchase shares in Royal Bank of Scotland (RBS), HBOS and Lloyd's TSB at what are now far above market prices. But sometimes someone puts something not in the most scientific way but in one that beautifully captures its essence. One example is a comment by Tony Peterson on The Independent's article on the threat to nationalise banks that refuse to lend at an appropriate level this morning. He comments on the Lloyd's TSB decision to 'allow' the government to purchase shares in it at 173.3p each.
'Here's a good one to watch for. At the Lloyds egm [Emergency General Meeting] I warned the board that they were likely to follow in the footsteps of the 1929 bankers who bought their own worthless stock and became the first men in history to swindle themselves. [Lloyds TSB chairman Sir Victor] Blank promised us that all his board would take up their full entitlement to new shares at 173.3p That evening the value fell to 118p. I've checked their holdings and calculated the level of self-swindle they are pledged to. Negative bonuses this year, chaps.'
The difference however is the following. If the directors of Lloyd's TSB want to 'swindle themselves' by buying their own company's shares at far above market prices that is their affair. It is quite a different one if the government forces everyone in the country, aka the taxpayer, to buy bank shares , through the bail-out package, at far above market prices regardless of whether they wish to or not. That would be to allow bank shareholders to swindle the taxpayer.
It is merely to add insult to injury when these same banks, having pocketed the taxpayers money at far above market prices, then don't lend to the rest of the economy.
Banks refusal to lend demonstrates the relation and difference between Keynesian and socialist economic approaches
The public row which has developed between the private banks and the government, reported in both the Financial Times and The Independent today, demonstrates both the limits of Keynesianism and makes clear the relation and difference between it and a fully socialist economic approach.
Regarding the row, as The Independent notes in its leading article today: 'The Government has already bailed out the banks with extra liquidity and injections of new capital. The Bank of England has acted drastically to reduce interest rates and is poised to go further. But so far the banks have still not responded with loans, mortgage rates or credit lines to their customers. As yesterday's CBI survey of smaller businesses illustrated, most firms are experiencing a drastic reduction in bank credit and a tightening in terms.'
These actions by banks threaten the entire economy - and therefore the well being of everyone. As The Independent notes of any proposed Keynesian economic recovery package to meet the economic downturn: 'The sort of fiscal stimulus now being planned can counter this by putting more money into people's pockets and providing more jobs through public investment. The problem of today – as in the great crash – is that the contraction comes hard on the heels of a banking and stock market crisis. Putting more money in the pockets of taxpayers, particularly at the lower end of the scale, can help. But it cannot work alone. For that you need credit to become more freely available at an attractive price.'
The paper then notes: 'From the banks' point of view, that [refusal to lend adequately] may be understandable. They badly need to rebuild their capital base and avoid a return to excessive risk. But from the nation's viewpoint, this is only making a bad situation worse. Banks must support the reflation package by restoring lending. If they will not do it of their own accord, then the Government should use the influence of its new shares and its powers to push them into more responsibility.'
The Financial Times, similarly in an editorial, deals with the same topic - warning of a threat of nationalisation if banks continue to act in their present fashion: '“Neither a borrower nor a lender be” was not intended as advice for bankers. Someone should tell them.
'The purpose of the recent round of recapitalisations was to strengthen banks so that they could continue lending during a global downturn. But banks are not doing so. They must. They are vital utilities – a modern economy cannot function without credit...
The Financial Times notes: 'Banks around the world have been recapitalised. Governments bought shares in them, increasing the banks’ risk-capital buffers. The banks were injected with enough capital not only to make up for the losses they were expected to make in the downturn, but also to allow them to expand their lending without the capital cushion becoming too small relative to the banks’ assets.
'Newly fortified, banks were supposed to become trustworthy borrowers and confident lenders. Expecting further losses, however, they have clammed up. They are wary of extending their balance sheets further. This is, in part, because they are still traumatised after a near-death experience. Many banks have also seen their top management decapitated. Finally, investors and banks have become so risk-averse that even government guarantees on lending are not convincing. Despite being underwritten by the US government, perceptions of the risk on Citigroup’s debts have remained stubbornly high.
The Financial Times argues: 'Governments can do more to support lending. They can reassure markets that capital ratios are supposed to fall in the downturn and that they stand behind the banks. Finance ministries around the world can recapitalise further. Central banks can expand their lender of last resort functions.
'If evidence emerges that banks are not lending because they are hoarding cash to pay off the expensive preference shares taken by governments, the rescue can be restructured. One option would be to give governments more control of the banks; another would be to reduce the short-term costs of the capital.
The paper concludes: 'even if governments ensure that lenders are solvent and liquid, it could still be rational for each bank not to lend. Banks want safety in numbers when it comes to lending. But a lack of credit would force sound companies under because of a working capital squeeze.'
The Financial Times therefore warns: 'If bankers do not start lending of their own accord, governments will force them to.... Faced with this prospect [of lack of adequate lending], governments will have no choice but to step in.
'Politicians may attempt to lend directly, taking on credit risk to stimulate certain categories of lending and insurance. But banks, which have always been dependent on the largesse of taxpayers, could be forced to adopt central targets for new lending. This would overcome the problem of no institution wishing to be the first-mover. And banks would have little choice but to obey; if they are unco-operative, they could end up in public ownership.'
Regarding the same threat of bank nationalisation Nigel Morris, The Independent's deputy political editor, notes: 'The Government is using the threat of a wholesale nationalisation of banks in an attempt to force institutions to lend billions to small companies struggling to survive as Britain slips into recession.
'Downing Street yesterday made plain its fury over high street banks which refuse to use the massive injection of taxpayers' money they have received to come to the rescue of businesses hit by the credit crisis...
'The financial stimulus package is designed to breathe new life into the economy but Mr Darling fears the behaviour of the banks could undermine the moves... He is expected to announce controls on the interest rates charged on small business loans...
'Ministers are irritated that banks the Treasury bailed out are dragging their feet over passing on the money. The Treasury took stakes in HBOS, Lloyds TSB and Royal Bank of Scotland in return for £37bn of public funds. The banks promised to return lending to last year's levels. John McFall, the chairman of the Treasury select committee and an ally of Mr Brown and Mr Darling, raised the prospect of state control, saying: "If the banks do not play ball, and will not resume lending, then the demand for full-scale nationalisation may well grow."
'No 10 refused to rule out such a step, regarded by officials as the "nuclear option". Mr Brown's spokesman said: "In these circumstances, of course we have got to look at all the options. But we want to work constructively with the banks to ensure they fulfil the commitments they have entered into."
'Asked a second time about full nationalisation, he replied: "It would clearly be foolish for anybody to rule out specific options at this stage."The Government has made little effort to disguise its frustration at the behaviour of banks towards small businesses and mortgage-payers.
Morris concludes: 'Mr Darling is preparing to use his pre-Budget report to fire a shot across their bows with tough demands on lending. He is not expected to impose further legal sanctions on banks, such as the appointment of a powerful watchdog to monitor lending rates, but officials want to keep options in reserve if the banks fail to respond. '
This is the dilemma of Keynesianism. What if the banks refuse to respond to voluntarily to government 'influence'? Will the government then say 'private property is sacrosanct. We know that banks refusal to lend is disastrous for the economy. But private property, in this case in banks, comes before the health of the economy and therefore of society. To preserve private property, we must surrender and allow the economy to go into slump'. That is the capitalist answer.
Or will a government say: 'We have tried indirect methods of stimulating bank lending but these have not worked - the banks are using their claimed right as private companies, that is as private property, to refuse to lend. The interests of society, that is of economic development, come before those of private property. Therefore such decisions will be taken out of the hands of the banks. The banks will be nationalised, that is their position as private property abolished, in order to commence the necessary lending to maintain the economy.' That is the socialist answer.
The dilemma of Keynesianism, at least as orginally put forward by Keynes, is this: because it accepts capitalism, that is private property, as the basis of society Keynesianism can only use indirect methods (fiscal deficits, monetary policy, interest rate policy), to attempt to influence the most fundamental issue - the investment decisions in the economy. For, if you take away the right of companies to take investment decisions, you in fact abolish them as private property - that is you abolish capitalism.
Keynesianism can, therefore, deal with minor or moderate economic crises - in these indirect methods are sufficiently powerful to cause investment to recommene and therefore to overcome the economic downturn. But if the economic crisis is really deep such indirect methods are not sufficiently strong. Private compaies will not resume investment and the economy will go into a downward spiral. In those circumstances the only economic way out is take the investment decisions out of the hands of the capitalists and into the hands of society by nationalisation - which means going forward from a Keynesian solution to a socialist one.
In the UK will the present financial crisis require a Keynesian or a socialist solution to overcome it? Regarding the overall economy that depends on how deep the economic crisis becomes. Does the UK face a severe economic recession or an economic depression? Socialist Economic Bulletin at present, for reasons it has outlined, analyses that the UK faces a severe economic recession not a full blown depression - although the reverse outcome could occur if the US makes catastrophic economic mistakes. While the moral case for socialism remains overwhelming it is unlikely, in this country, that it will be impossible to get out of the current economic downturn without resorting to fully socialist measures - that is a wholesale programme of nationalisation. Considering the economy as a whole, a Keynesian/capitalist way to overcome the economic crisis will be carried out.
But that overall perspective not only does not apply to every country in the world it does not apply to every part of the UK economy. In the financial sector, both in the UK and in the US, what is faced is not recession but a catastrophic collapse comparable only to 1929. It is already the case that the most rational, and by far the cheapest, way to sort out the disastrous situation in the UK financial sector would be to proceed immediately to wholesale bank nationalisation. The immedite crisis, whereby the banks are refusing to lend even after the bail out packages, may make it the case that the only way out of the economic downturn is by wholesale bank nationalisation - a sort of Keynesian solution in the overall economy and a socialist solution in the catastrophically affected financial sector.
Indeed, t may be put more strongly. If the government retreats in face of the present policies by the banks, with their refusal to lend then it will not be possible to apply a Keynesian policy in the overall economy. Truly socialist policies, nationalisation, in the financial sector may well turn out to be the only way to apply Keynesian policies in the economy as a whole.
Regarding the row, as The Independent notes in its leading article today: 'The Government has already bailed out the banks with extra liquidity and injections of new capital. The Bank of England has acted drastically to reduce interest rates and is poised to go further. But so far the banks have still not responded with loans, mortgage rates or credit lines to their customers. As yesterday's CBI survey of smaller businesses illustrated, most firms are experiencing a drastic reduction in bank credit and a tightening in terms.'
These actions by banks threaten the entire economy - and therefore the well being of everyone. As The Independent notes of any proposed Keynesian economic recovery package to meet the economic downturn: 'The sort of fiscal stimulus now being planned can counter this by putting more money into people's pockets and providing more jobs through public investment. The problem of today – as in the great crash – is that the contraction comes hard on the heels of a banking and stock market crisis. Putting more money in the pockets of taxpayers, particularly at the lower end of the scale, can help. But it cannot work alone. For that you need credit to become more freely available at an attractive price.'
The paper then notes: 'From the banks' point of view, that [refusal to lend adequately] may be understandable. They badly need to rebuild their capital base and avoid a return to excessive risk. But from the nation's viewpoint, this is only making a bad situation worse. Banks must support the reflation package by restoring lending. If they will not do it of their own accord, then the Government should use the influence of its new shares and its powers to push them into more responsibility.'
The Financial Times, similarly in an editorial, deals with the same topic - warning of a threat of nationalisation if banks continue to act in their present fashion: '“Neither a borrower nor a lender be” was not intended as advice for bankers. Someone should tell them.
'The purpose of the recent round of recapitalisations was to strengthen banks so that they could continue lending during a global downturn. But banks are not doing so. They must. They are vital utilities – a modern economy cannot function without credit...
The Financial Times notes: 'Banks around the world have been recapitalised. Governments bought shares in them, increasing the banks’ risk-capital buffers. The banks were injected with enough capital not only to make up for the losses they were expected to make in the downturn, but also to allow them to expand their lending without the capital cushion becoming too small relative to the banks’ assets.
'Newly fortified, banks were supposed to become trustworthy borrowers and confident lenders. Expecting further losses, however, they have clammed up. They are wary of extending their balance sheets further. This is, in part, because they are still traumatised after a near-death experience. Many banks have also seen their top management decapitated. Finally, investors and banks have become so risk-averse that even government guarantees on lending are not convincing. Despite being underwritten by the US government, perceptions of the risk on Citigroup’s debts have remained stubbornly high.
The Financial Times argues: 'Governments can do more to support lending. They can reassure markets that capital ratios are supposed to fall in the downturn and that they stand behind the banks. Finance ministries around the world can recapitalise further. Central banks can expand their lender of last resort functions.
'If evidence emerges that banks are not lending because they are hoarding cash to pay off the expensive preference shares taken by governments, the rescue can be restructured. One option would be to give governments more control of the banks; another would be to reduce the short-term costs of the capital.
The paper concludes: 'even if governments ensure that lenders are solvent and liquid, it could still be rational for each bank not to lend. Banks want safety in numbers when it comes to lending. But a lack of credit would force sound companies under because of a working capital squeeze.'
The Financial Times therefore warns: 'If bankers do not start lending of their own accord, governments will force them to.... Faced with this prospect [of lack of adequate lending], governments will have no choice but to step in.
'Politicians may attempt to lend directly, taking on credit risk to stimulate certain categories of lending and insurance. But banks, which have always been dependent on the largesse of taxpayers, could be forced to adopt central targets for new lending. This would overcome the problem of no institution wishing to be the first-mover. And banks would have little choice but to obey; if they are unco-operative, they could end up in public ownership.'
Regarding the same threat of bank nationalisation Nigel Morris, The Independent's deputy political editor, notes: 'The Government is using the threat of a wholesale nationalisation of banks in an attempt to force institutions to lend billions to small companies struggling to survive as Britain slips into recession.
'Downing Street yesterday made plain its fury over high street banks which refuse to use the massive injection of taxpayers' money they have received to come to the rescue of businesses hit by the credit crisis...
'The financial stimulus package is designed to breathe new life into the economy but Mr Darling fears the behaviour of the banks could undermine the moves... He is expected to announce controls on the interest rates charged on small business loans...
'Ministers are irritated that banks the Treasury bailed out are dragging their feet over passing on the money. The Treasury took stakes in HBOS, Lloyds TSB and Royal Bank of Scotland in return for £37bn of public funds. The banks promised to return lending to last year's levels. John McFall, the chairman of the Treasury select committee and an ally of Mr Brown and Mr Darling, raised the prospect of state control, saying: "If the banks do not play ball, and will not resume lending, then the demand for full-scale nationalisation may well grow."
'No 10 refused to rule out such a step, regarded by officials as the "nuclear option". Mr Brown's spokesman said: "In these circumstances, of course we have got to look at all the options. But we want to work constructively with the banks to ensure they fulfil the commitments they have entered into."
'Asked a second time about full nationalisation, he replied: "It would clearly be foolish for anybody to rule out specific options at this stage."The Government has made little effort to disguise its frustration at the behaviour of banks towards small businesses and mortgage-payers.
Morris concludes: 'Mr Darling is preparing to use his pre-Budget report to fire a shot across their bows with tough demands on lending. He is not expected to impose further legal sanctions on banks, such as the appointment of a powerful watchdog to monitor lending rates, but officials want to keep options in reserve if the banks fail to respond. '
This is the dilemma of Keynesianism. What if the banks refuse to respond to voluntarily to government 'influence'? Will the government then say 'private property is sacrosanct. We know that banks refusal to lend is disastrous for the economy. But private property, in this case in banks, comes before the health of the economy and therefore of society. To preserve private property, we must surrender and allow the economy to go into slump'. That is the capitalist answer.
Or will a government say: 'We have tried indirect methods of stimulating bank lending but these have not worked - the banks are using their claimed right as private companies, that is as private property, to refuse to lend. The interests of society, that is of economic development, come before those of private property. Therefore such decisions will be taken out of the hands of the banks. The banks will be nationalised, that is their position as private property abolished, in order to commence the necessary lending to maintain the economy.' That is the socialist answer.
The dilemma of Keynesianism, at least as orginally put forward by Keynes, is this: because it accepts capitalism, that is private property, as the basis of society Keynesianism can only use indirect methods (fiscal deficits, monetary policy, interest rate policy), to attempt to influence the most fundamental issue - the investment decisions in the economy. For, if you take away the right of companies to take investment decisions, you in fact abolish them as private property - that is you abolish capitalism.
Keynesianism can, therefore, deal with minor or moderate economic crises - in these indirect methods are sufficiently powerful to cause investment to recommene and therefore to overcome the economic downturn. But if the economic crisis is really deep such indirect methods are not sufficiently strong. Private compaies will not resume investment and the economy will go into a downward spiral. In those circumstances the only economic way out is take the investment decisions out of the hands of the capitalists and into the hands of society by nationalisation - which means going forward from a Keynesian solution to a socialist one.
In the UK will the present financial crisis require a Keynesian or a socialist solution to overcome it? Regarding the overall economy that depends on how deep the economic crisis becomes. Does the UK face a severe economic recession or an economic depression? Socialist Economic Bulletin at present, for reasons it has outlined, analyses that the UK faces a severe economic recession not a full blown depression - although the reverse outcome could occur if the US makes catastrophic economic mistakes. While the moral case for socialism remains overwhelming it is unlikely, in this country, that it will be impossible to get out of the current economic downturn without resorting to fully socialist measures - that is a wholesale programme of nationalisation. Considering the economy as a whole, a Keynesian/capitalist way to overcome the economic crisis will be carried out.
But that overall perspective not only does not apply to every country in the world it does not apply to every part of the UK economy. In the financial sector, both in the UK and in the US, what is faced is not recession but a catastrophic collapse comparable only to 1929. It is already the case that the most rational, and by far the cheapest, way to sort out the disastrous situation in the UK financial sector would be to proceed immediately to wholesale bank nationalisation. The immedite crisis, whereby the banks are refusing to lend even after the bail out packages, may make it the case that the only way out of the economic downturn is by wholesale bank nationalisation - a sort of Keynesian solution in the overall economy and a socialist solution in the catastrophically affected financial sector.
Indeed, t may be put more strongly. If the government retreats in face of the present policies by the banks, with their refusal to lend then it will not be possible to apply a Keynesian policy in the overall economy. Truly socialist policies, nationalisation, in the financial sector may well turn out to be the only way to apply Keynesian policies in the economy as a whole.
Dow Jones so far continues to track its 1929 decline
Socialist Economic Bulletin has emphasised the significant danger in current economic and government policy of underestimation of downside risk in share prices. This is fully confirmed by the latest movements of the Dow Jones Industrial Average which are illustrated in Figure 1.
This graph compares the daily movement of the Dow following its peak on 3 September 1929 with its movement following its peak on 9 October 2007. As may be seen the decline in the Dow in the current financial crisis is entirely comparable in magnitude, at this stage, to its fall in 1929-32 - this data updates trends analysed in SEB in October.
In order to show that such a severe decline in nominal share prices is a specific feature of the 1929 and 2007 crises, and not typical of any recession, Figure 2 shows a similar graph for the four most serious declines in the Dow in the last century - those starting in 1929, 1973, 2000, and 2007.
For the three earlier declines the data covers the period from the peak price preceding the decline to its low point. The data for the decline starting in 2007 are up to the latest available date - the close of trading on 20 November 2008.
It may be seen that the falls in nominal prices starting in 1973, associated with the oil price increases and recession of that year, and in 2000, following the bursting of the dot com financial bubble, were far less severe than the drops in either 1929 or in 2007.
The fall in real terms following 1973 is understated by this graph, as at that time inflation was far higher than in 1929, 2000 or 2007, while the decline in real terms following 1929 is somewhat exaggerated as at that time the overall price level in the economy was falling. But the differences of order of magnitude are sufficient to make the pattern clear. The fall in nominal share prices following both 1929 and 2007 far exceeds that of any other drop in the last century.
From the angle of share prices it is entirely justified, and without exaggeration, to speak of the present crisis as comparable only to 1929.
The difference between the fall starting in 2007 and that in 1929 is only, at present, the duration of the decline. The decline after 1929 continued for 712 trading days before reaching its bottom on 7 July 1932. The decline following the peak of 9 October 2007 has so far continued for 284 trading days - slightly under forty per cent of the period of the decline following 1929.
Far more prolonged falls in share prices than in 1929 are, however, possible. The Japanese Nikkei, to take the extreme case, was still setting new lows 18 years following its peak at the end of 1989.
For these reasons, to return to the point made at the beginning, there continues to be considerable underestimation of downside risk in share prices in current economic and government policy.
This article is a shortened version of one which appeared on Key Trends in Globalisation.
This graph compares the daily movement of the Dow following its peak on 3 September 1929 with its movement following its peak on 9 October 2007. As may be seen the decline in the Dow in the current financial crisis is entirely comparable in magnitude, at this stage, to its fall in 1929-32 - this data updates trends analysed in SEB in October.
Figure 1
In order to show that such a severe decline in nominal share prices is a specific feature of the 1929 and 2007 crises, and not typical of any recession, Figure 2 shows a similar graph for the four most serious declines in the Dow in the last century - those starting in 1929, 1973, 2000, and 2007.
For the three earlier declines the data covers the period from the peak price preceding the decline to its low point. The data for the decline starting in 2007 are up to the latest available date - the close of trading on 20 November 2008.
Figure 2
It may be seen that the falls in nominal prices starting in 1973, associated with the oil price increases and recession of that year, and in 2000, following the bursting of the dot com financial bubble, were far less severe than the drops in either 1929 or in 2007.
The fall in real terms following 1973 is understated by this graph, as at that time inflation was far higher than in 1929, 2000 or 2007, while the decline in real terms following 1929 is somewhat exaggerated as at that time the overall price level in the economy was falling. But the differences of order of magnitude are sufficient to make the pattern clear. The fall in nominal share prices following both 1929 and 2007 far exceeds that of any other drop in the last century.
From the angle of share prices it is entirely justified, and without exaggeration, to speak of the present crisis as comparable only to 1929.
The difference between the fall starting in 2007 and that in 1929 is only, at present, the duration of the decline. The decline after 1929 continued for 712 trading days before reaching its bottom on 7 July 1932. The decline following the peak of 9 October 2007 has so far continued for 284 trading days - slightly under forty per cent of the period of the decline following 1929.
Far more prolonged falls in share prices than in 1929 are, however, possible. The Japanese Nikkei, to take the extreme case, was still setting new lows 18 years following its peak at the end of 1989.
For these reasons, to return to the point made at the beginning, there continues to be considerable underestimation of downside risk in share prices in current economic and government policy.
* * *
This article is a shortened version of one which appeared on Key Trends in Globalisation.
Where financial gangrene threatens to develop in the US financial system
Socialist Economic Bulletin has noted that the huge financial effort put into trying to prevent the collapse of the most important, that is the system making, banks is draining resources out of the rest, i.e. 'the periphery', of the financial system.
Alongside the effect this is having on countries such as the Ukraine, Pakistan, and Argentina, an important new paper by Victoria Ivashina and David Scharfstein of the Harvard Business school analyses the operation of this process within the US financial system itself.
They note that in the US: 'new loans to large borrowers fell by 36% during the peak period of the financial crisis (August-October 2008) relative to the prior three-month period and by 60% relative to the peak of the credit boom (May-July 2007)...
'Although new lending has fallen, since September 2008, there has been a sharp increase in commercial and industrial (C&I) loans reported on the balance sheets of U.S. banks... [Some analysts have] interpret[ed] this as new bank lending; however, our evidence is inconsistent with this view. Instead, we suggest that the rise in C&I loans on bank balance sheets comes in good measure from an increase in drawdowns on pre-existing revolving credit facilities ("revolvers").
'These drawdowns are not just from high quality borrowers who are shifting from the commercial paper market because of disruptions in that market. Many of them are very large, low credit-quality borrowers, who are now borrowing on the generous terms that were offered during the credit boom, though they are now much riskier. While this may help these firms, it may also crowd out new lending to other firms. The amount of outstanding revolvers is very large, and banks may be holding back on new loans to protect against flood of draw-downs if the economy continues to deteriorate.'
They conclude: 'New lending in 2008 was significantly below new lending in 2007, even before the peak period of the financial crisis (August-October 2008)... new lending to large corporate borrowers peaked in the period, May-July 2007. In September 2007, concerns about the credit risk of all types of collateralized debt obligations (CDOs), led to a drop in institutional demand for syndicated loans... By May-July 2008, lending was 38 per cent lower than the peak of the credit boom....
'The decline in new loans accelerated during the financial crisis, falling by 36 per cent in the August-October 2008 period relative to the prior three-month period. Thus, bank loans fell from $667.4 billion in May-July 2007, the peak of the credit boom, to $414.8 a year later, and then to $264.7 billion three months later in the August-October 2008 period. The drop in October, 2008 was particularly steep. Lending during the peak financial crisis period was just 40 per cent of peak lending little over a year earlier...
'During the peak period of the financial crisis (August-October 2008), non-investment-grade loans fell by 50% relative to the prior period, while investment grade loans fell by 19%. '
This analysis describes graphically how blood is being drained out of the US financial system despite the huge increase in taxpayer bailout activites to the banks.
Noting the operation of this process the Wall Street Journal comments: The worst of the credit crisis is being felt not in banks but in financial markets. Loans from a bank might stay on its books. Increasingly in the past decade, loans were packaged into securities and sold to investors around the world - pension funds, endowments, mutual funds, hedge funds and others. Institutional investors gobbled up this and other kinds of credit that didn't come via traditional commercial banks, such as junk bonds or commercial paper.
'To get credit flowing, policy makers need to repair financial markets as well as banks. But investor confidence in credit markets has been shattered, in part because many debt securities performed so much worse than their credit ratings suggested they would.
'Issuance of asset-backed securities - instruments used to package credit-card and auto-loan debt during the boom - was down 79% in the year through October from last year, to $142 billion, according to Dealogic data. In 2005 and 2006, investors snapped up more than a trillion dollars of these instruments. Junk-bond issuance was down 66% in the first 10 months of the year from the same period in 2007. '
In short, the system making banks have been propped up through very large transfers of taxpayers funds. Financial circulation has been restored in the core of the system. But circulation is stopping in the periphery of the system both geographically and in terms of financial markets within the most economically developed economies themselves. This is now where the credit crunch is most advanced.
In addition to the importance of this development itself a key issue will be whether the poisons being produced from this financial gangrene will invade the core of the financial system again.
Alongside the effect this is having on countries such as the Ukraine, Pakistan, and Argentina, an important new paper by Victoria Ivashina and David Scharfstein of the Harvard Business school analyses the operation of this process within the US financial system itself.
They note that in the US: 'new loans to large borrowers fell by 36% during the peak period of the financial crisis (August-October 2008) relative to the prior three-month period and by 60% relative to the peak of the credit boom (May-July 2007)...
'Although new lending has fallen, since September 2008, there has been a sharp increase in commercial and industrial (C&I) loans reported on the balance sheets of U.S. banks... [Some analysts have] interpret[ed] this as new bank lending; however, our evidence is inconsistent with this view. Instead, we suggest that the rise in C&I loans on bank balance sheets comes in good measure from an increase in drawdowns on pre-existing revolving credit facilities ("revolvers").
'These drawdowns are not just from high quality borrowers who are shifting from the commercial paper market because of disruptions in that market. Many of them are very large, low credit-quality borrowers, who are now borrowing on the generous terms that were offered during the credit boom, though they are now much riskier. While this may help these firms, it may also crowd out new lending to other firms. The amount of outstanding revolvers is very large, and banks may be holding back on new loans to protect against flood of draw-downs if the economy continues to deteriorate.'
They conclude: 'New lending in 2008 was significantly below new lending in 2007, even before the peak period of the financial crisis (August-October 2008)... new lending to large corporate borrowers peaked in the period, May-July 2007. In September 2007, concerns about the credit risk of all types of collateralized debt obligations (CDOs), led to a drop in institutional demand for syndicated loans... By May-July 2008, lending was 38 per cent lower than the peak of the credit boom....
'The decline in new loans accelerated during the financial crisis, falling by 36 per cent in the August-October 2008 period relative to the prior three-month period. Thus, bank loans fell from $667.4 billion in May-July 2007, the peak of the credit boom, to $414.8 a year later, and then to $264.7 billion three months later in the August-October 2008 period. The drop in October, 2008 was particularly steep. Lending during the peak financial crisis period was just 40 per cent of peak lending little over a year earlier...
'During the peak period of the financial crisis (August-October 2008), non-investment-grade loans fell by 50% relative to the prior period, while investment grade loans fell by 19%. '
This analysis describes graphically how blood is being drained out of the US financial system despite the huge increase in taxpayer bailout activites to the banks.
Noting the operation of this process the Wall Street Journal comments: The worst of the credit crisis is being felt not in banks but in financial markets. Loans from a bank might stay on its books. Increasingly in the past decade, loans were packaged into securities and sold to investors around the world - pension funds, endowments, mutual funds, hedge funds and others. Institutional investors gobbled up this and other kinds of credit that didn't come via traditional commercial banks, such as junk bonds or commercial paper.
'To get credit flowing, policy makers need to repair financial markets as well as banks. But investor confidence in credit markets has been shattered, in part because many debt securities performed so much worse than their credit ratings suggested they would.
'Issuance of asset-backed securities - instruments used to package credit-card and auto-loan debt during the boom - was down 79% in the year through October from last year, to $142 billion, according to Dealogic data. In 2005 and 2006, investors snapped up more than a trillion dollars of these instruments. Junk-bond issuance was down 66% in the first 10 months of the year from the same period in 2007. '
In short, the system making banks have been propped up through very large transfers of taxpayers funds. Financial circulation has been restored in the core of the system. But circulation is stopping in the periphery of the system both geographically and in terms of financial markets within the most economically developed economies themselves. This is now where the credit crunch is most advanced.
In addition to the importance of this development itself a key issue will be whether the poisons being produced from this financial gangrene will invade the core of the financial system again.
Mounting dangers to the taxpayer of the government proposal to buy shares in RBS, HBOS, and Lloyd's TSB
Socialist Economic Bulletin (SEB) has repeatedly warned of the danger of very serious losses to the UK taxpayer if the government proceeds with its proposal to buy shares in Royal Bank of Scotland (RBS), HBOS, and Lloyds TSB. The government agreed to purchase these at a price per share of, respectively, 65.5p, 113.6p and 173.3p. It was claimed these were being bought 'at the bottom of the market'. SEB warned that, first, it was not an acceptable risk to the taxpayer for the government to become involved in attempting to judge the price of shares, and second any view that these shares had reached their bottom was likely to be seriously flawed as the government was underestimating the historical dangers of very prolonged depression of share prices. Other commentators have since strongly made the same point.
This danger is graphically revealed by the movement of these bank share prices under the impact of the further deepening of the international financial crisis. At noon on 17 November the prices of RBS, HBOS, and Lloyds TSB were respectively 49.1p, 77.0p and 149.6p.
This means that Lloyds TSB shares were 14 per cent below the price the government proposed to purchase them at, RBS shares were 25 per cent below, and HBOS shares were 32 per cent below.
This shows, first, that it was false to say that the proposed purchase prices were 'at the bottom of the market' and second that is is quite wrong for the government to be using taxpayers money to purchase shares at prices that are far above the market level. Purchase of shares at far above market prices is to subsidise shareholders while taxpayers suffer large losses.
The government should stand ready to take over companies that fail in order to ensure functioning of the banking system - as it did with Northern Rock and Bradford and Bingley. It should not be purchasing shares at far above market prices.
This danger is graphically revealed by the movement of these bank share prices under the impact of the further deepening of the international financial crisis. At noon on 17 November the prices of RBS, HBOS, and Lloyds TSB were respectively 49.1p, 77.0p and 149.6p.
This means that Lloyds TSB shares were 14 per cent below the price the government proposed to purchase them at, RBS shares were 25 per cent below, and HBOS shares were 32 per cent below.
This shows, first, that it was false to say that the proposed purchase prices were 'at the bottom of the market' and second that is is quite wrong for the government to be using taxpayers money to purchase shares at prices that are far above the market level. Purchase of shares at far above market prices is to subsidise shareholders while taxpayers suffer large losses.
The government should stand ready to take over companies that fail in order to ensure functioning of the banking system - as it did with Northern Rock and Bradford and Bingley. It should not be purchasing shares at far above market prices.
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