Barclays, Vince Cable and the price of independence

Barclays plc is planning to boost its capital by raising money from investors in Abu Dhabi and Qatar. It's a complicated package and it looks expensive. Here's how the Telegraph website describes the deal:

"For starters, Barclays is paying a 14pc coupon for 10 years on some preferred-like shares. It's the highest rate yet for bank capital. True, the after-tax rate of 10pc is cheaper than the UK government's 12pc – but Barclays probably will be shelling out for at least six more years than its peers getting bailed out by the authorities.

Next, there are warrants – handed over at an in-the-money price and with anti-dilution protection. The Middle Eastern investors can subscribe to 1.5bn new ordinary shares at the severely depressed price of 198p each any time over the next five years.

Then come £2.8bn of mandatory convertible notes. Taking the 9.75pc coupon into account, the conversion price is 27pc below the pre-deal share price. There is also a generous thank you from Barclays - £300m of commissions, which get paid to Abu Dhabi and Qatar regardless of whether the deal goes ahead."

The commissions are pretty stunning, but they're really a sort of "drop dead fee", probably inserted as an inducement for the bank's existing shareholders to back the deal. (They get to vote on it later in the year). After all, they'll be throwing the £300 mil away if they don't.

The Government and most politicians are likely to welcome this initiative, but there's at least one exception. Here's Lib Dem Treasury spokesman Vince Cable, quoted on the Guardian website:

"The deal allows Barclays to strengthen its balance sheet without getting help from the taxpayer, but its terms, which are seen as generous to its new investors, drew fierce criticism today from Liberal Democrat deputy leader and Treasury spokesman Vince Cable.

"This is a scandal of mammoth proportions," he said. "Here is a bank which relies on the taxpayer to bail it out if the going gets rough but which has offered Middle Eastern investors a much better deal than the banks are offering to the British taxpayer."

Cable has been impressive throughout the financial crisis, but these comments are plain nuts. The comment that Barclays "relies on the taxpayer to bail it out" is particularly bizarre, given that the precise reason the bank is doing this deal is to avoid relying on the taxpayer.

Cable goes on to offer his explanation as to why Barclays is going down this road:

"We have to ask why Barclays it is willing to offer a better deal to foreign investors than the British taxpayer," Cable said. "The answer is simple: they don't want the British government stopping them from paying massive bonuses to their executives.

"More than the other banks, Barclays operate a high-risk casino operation which makes the bank particularly unstable but which gives very rich pickings to the top executives. The British government must not simply let this pass."

Leaving aside the accusations in the second paragraph of that quote -- which might well be actionable if uttered by anyone other than a politician -- Cable's explanation doesn't really hold up. The public likes (or should I say hates) to imagine bankers going home on bonus day with the boots of their Bentleys stuffed with crisp new 50s. In truth, most bankers get a large chunk of their bonuses paid in the form of stock, and have to wait years to convert it into cash. A deal like this one, which will certainly weigh on the stock price until the warrants and the convertibles are exercised, is the last thing they'd want.

So why are Barclays' management recommending this deal to shareholders? The classically-named chairman, Marcus Agius, says "it's all about self determination". With the press reporting today that the Government is putting pressure on the banks that have been bailed out to boost lending levels, it's not difficult to believe him.

A big day for bad ideas

On Monday evening Channel 4 showed a hastily-assembled documentary called "Don't bank on the bailout", presented by city fund manager Hugh Hendry. I didn't catch the whole thing, but the parts I did manage to see were, shall we say, unimpressive. Hendry appeared completely unaware of the difference between the annual budget deficit and the national debt. He intoned meaningless sentences like "four and a half is the new fifteen", referring to the level of Bank Rate. He invented scary numbers for the sake of effect, airily dismissing a carefully-researched study that suggested the budget deficit could reach £90 billion with the words "try £200 billion".

According to Hendry, it may be too late to avoid a recession in the UK, but if we are to do so, we need to return to old fashioned austerity. That's a great idea, Hugh. Let's prevent an accidental recession by causing one deliberately, because that's certainly what would happen if both individuals and governments stopped spending. Oddly, Hugh also wants a massive rate cut, which most of us would not see as the most obvious route to austerity. Looks like Channel 4 should stick to Big Brother. As for Hugh Hendry, he might want to spend more time with his funds, as he underperformed the market by almost 8 percentage points in the third quarter of 2008, according to Citywire.

Not that the UK has a monopoly on madcap ideas. Also on Monday, I came across Maria Bartiromo interviewing a panel of distinguished guests. First up was Arthur Laffer, he of the fatuous Laffer curve, who was bemoaning the financial market bailout because it would have to be paid for through higher taxes eventually. (Yes, it's all right for millions of people to lose their homes, as long as Art and his pals don't have to pay any more taxes). Then it was on to Lawrence Kudrow, who was foaming at the mouth at an old quote from Barack Obama, in which Obama said it was a shame that the black power movement had failed to redistribute income. Larry said the government should not worry about how much of the pie everyone got; it should just try to make sure the pie got bigger. He also asserted that Obama would use the courts to redistribute wealth if he could. Pretty clearly, Larry is one of the surprising number of people in the US who think the credit crisis was caused by the poor.

I had to stop watching at this point in order to avoid putting a boot through the TV. If I'd kept watching, Maria's next guest might well have been Jude Wanniski, reaching back from beyond the grave to call for restoration of the gold standard.

So much for "Dow 36000"

A few weeks and many Dow gyrations ago, I heard Maria Bartiromo on CNBC ask one of her equally excitable on-air colleagues "how long can this go on?" It's clear enough now that "this" -- wild stock market fluctuations around a generally bearish trend -- could go on for some time yet. On Friday, for the first time, one of the CNBC talking heads blurted out the previously unthinkable, saying something on the following lines: "once this liquidation is over, some of the pension types may never put their money back into stocks. We could see the market staying at depressed levels for years".

Indeed we could. The bull market has been in place for so long that a lot of people have forgotten what bear markets look like. This is especially true for a lot of the on-air staff at TV stations like CNBC and Bloomberg, who are too young to have real memories of the last one. (The lovely Maria, who is a bit older than she wants you to think, may be an exception). The fact is, though, that bear markets can last a long time. People might be a bit less keen to make comparisons with the 1929 crash and the ensuing depression if they realised just how long the market remained in the dumper: it was 1954 before Dow got back to its 1929 level. That's an awfully long time for the "pension types" and their clients. (You can see a graph of the Dow since 1900, together with an explanation of the rather odd way in which it's calculated, here.)

Even more recently, the Dow has wallowed for years on end. When I first started paying attention to stock markets as a youth, the average never seemed to be able to break above 1000. In fact, it stayed just below that level throughout the 1960s, and it was only the onset of the great inflation of the 1970s that finally gave it a kick higher. If we are entering an era of slow growth and possibly even deflation, we could very well see a similarly long period of sideways trading now, as my man at CNBC has belatedly acknowledged.

People are trying to look for the bright side of a downturn: return to traditional values, that sort of thing. For the more venal, though, this may also be a period in which the foundations of the next great fortunes are laid. As in the 1930s, those lucky enough still to have cash will be able to pick up some great assets at bargain prices -- though it may be their kids or even their grandchildren that reap most of the benefits.

You call that an apology?

Former Fed Chairman Alan Greenspan has probably come as close as he ever will to accepting some culpability for the unfolding economic meltdown. Under harsh questioning in Congress, he announced that he had uncovered a "flaw" in the economic philosophy that had stood him in such good stead for the past forty years.

In the usual Greenspan way, it's a bit difficult to figure out just what he thinks the "flaw" is. However, it seems to be something to do with overestimating the ability of bank shareholders to act in their own self-interest. That's right -- his only mistake was in misjudging the stupidity of others. He's certainly not admitting that it might just possibly have been a mistake for the Fed to cut interest rates every time the markets even quivered. Nor would it occur to him that the behaviour of bank shareholders that he now deplores might in any way have been influenced by the irresponsible monetary policy pursued by the Fed.

Everyone's jumping on the "bash the maestro" bandwagon now, so much so that those of us who've been on it for years are starting to find it a bit claustrophobic. When Greenspan was awarded his honorary KBE by the Queen a few years ago, I wrote in my Bloomberg message header that it must stand for "King of the Bubble Economy". Hey Al, can we have our gong back, please?

What were they thinking?

It's staggering to behold the parade of UK investors who are still coming forward and admitting they stand to lose money as a result of the collapse of Iceland's banking system. (Or to put it another way, it's staggering to discover the lengths to which those banks went to fund themselves).

First we had the personal depositors in Icesave, Heritable and Kaupthing Edge, all of whom seem likely to get their money back eventually, probably at the expense of the British taxpayer. Then there were the dozens of local councils, hospital trusts, police authorities and what have you, who kept piling money into the Icelandic banks even though some of their smarter brethren had seen the writing on the wall months ago and brought their money home. The Government seems to think that these folk should have known better, and is resisting calls to compensate them.

Last week we started to hear tales of people who had seen fit to strap on another level of risk by investing in an Isle of Man sub of a UK sub of Kaupthing Bank. I've seen tales of woe of people with upwards of a million pounds invested in this way, and because the deals were placed in an insurance "wrapper", they may only ever see £50 of their money back. It's impossible not to feel sorry for these people, but at the same time you have to ask why they would think it wise to invest the bulk of their life savings in something that's so opaque, especially without deposit insurance.

And today we hear that the Barnsley Building Society had £10 million with one of the Icelandic banks, and has decided to sell itself to the Yorkshire Building Society in the best interest of its members. Those members, of course, won't be given any vote on the matter, any more, presumably, than they were consulted about putting the society's surplus funds into Iceland in the first place.

Predictably, the Barnsley's bosses are trying to dodge any blame: "The current exceptional situation in Iceland and the full extent of the repercussions were beyond anticipation," said its acting chief executive, Steve Mitchell. He's wrong about that, of course -- even the preternaturally useless ratings agencies were starting to fret about Iceland months ago.

So what were all of these people thinking? As Hank Paulson said of the whole credit mess, "there's plenty of blame to go round". However, in this particular case I think a special mention goes to those "best buy" lists that you find in the weekend papers. These were still touting Kaupthing and Heritable the day before the whole pack of cards collapsed. Last weekend those names were gone, but things like "ICICI Bank" and "Earl Shilton BS" featured prominently alongside the Nationwides and HSBCs of this world. I looked carefully for any warning about risks, credit ratings, deposit insurance coverage or anything of the sort, but there was none. These tables are based solely on price, making them virtually an inducement to the greedy or naive to gamble. Investing money is a big decision -- shouldn't the "quality" papers think twice about providing such incomplete advice to their readers?

Be nicer to Iceland???

People are starting to write into the media castigating the UK Government's hard line toward Iceland, in the face of the collapse of that country's financial system (and maybe its economy too). Some of the objections centre on the Government's use of anti-Terrorism legislation to seize the UK assets of Landsbanki and Kaupthing -- objections on the lines of "see? Once you give Governments that kind of power for particular purposes, they'll use it when they're not supposed to". I guess there is some merit in this, but most of the opinions I've seen from lawyers suggest that the anti-Terrorism law was used because it was the quickest way to meet the Government's objectives. There were other ways the Government could have achieved the same ends, but they would have taken time, time which in the circumstances the Government maybe felt it didn't have.

Most of the objections, though, just criticise the Government for general heavy handedness. One letter-writer described Iceland as "the least threatening people on earth". This seems a bit rich, considering the past history of bad blood between the two countries, especially during the "cod wars" a generation or two ago. The Icelandic government was both duplicitous and belligerent at that time. It was not exactly scrupulous over the legal niceties when it unilaterally extended its territorial waters no fewer than three times, so it's a bit rich of Prime Minister Geir Haarde to act all offended at the UK's actions now. (How weird is it that the Icelandic PM is a virtual namesake of the founder of the UK Labour Party??)

Let's think about this in a slightly abstract way for a second. Ignore the individual companies involved and think in terms of Iceland plc and UK plc. Iceland plc has borrowed a lot of money from UK plc and has used the money to buy some of UK plc's assets. Now Iceland plc can't pay the money back. Is it so unreasonable for UK plc to seize back its assets? I've been involved in a number of what are euphemistically called "distressed situations" in banking, and the UK Government's actions are pretty much what any banker would do in a comparable situation.

It is, of course, a bit more complicated when you put back more of the detail: three privately-owned Icelandic banks buying private UK assets. However, the Icelandic banking system is very unusual. The banks have not been in the private sector for very long, and in the case of Kaupthing, founded only in 1982, don't have a very long track record. The links between the central bank and the private banks are exceptionally tight, or to put it another way, the regulatory system is inadequate. The banks have grown stupendously fast almost entirely on the basis of taking deposits outside Iceland and lending that money for the purchase of assets outside the country. So Iceland doesn't account for most of their business, doesn't regulate them adequately and admits it can't provide the deposit insurance it promised. In what sense are these Icelandic banks? It seems no more than a flag of convenience, the equivalent of registering oil tankers in Liberia or Panama.

I'm not privy to the UK Government's thinking on this, but it seems to me they must have focused on a nightmare scenario: Icelandic companies sell their UK assets and repatriate the proceeds to Iceland, where they're used to pay back some of the banks' domestic depositors, leaving the UK savers high and dry. You can imagine the media outcry if that had been allowed to happen. None of this changes my view that the UK Government should have thought twice before agreeing to pay back all those who chose to save with the Icelandic banks, but it's surely justified in doing everything it can to minimise the cost to the UK Treasury of those banks' failure.

The musical ride

Once things settle down in the financial sector, attention will start to turn to the question of how the Government will pay for the bailout. Tax hikes? Spending cuts? The correct course would probably be to do nothing, as either raising taxes or cutting spending would slow the economy. The sooner the economy gets back on track, the sooner the Government is likely to be able to punt its newly-acquired bank shares back into the market at a profit to the taxpayer. Rising GDP would also begin to rein in the debt-to-GDP ratio that everyone seems to be worrying about.

There's a good precedent for the "do nothing approach". Canada dug itself into a dire fiscal mess in the 1980s, with the public debt/GDP ratio topping 100%. (By comparison, most estimates suggest that even with the bank bailout in full swing, the UK's ratio is unlikely to go much above 50%). Whenever there were calls for spending cuts in Canada, public servants always made sure that one thing topped the list: the Mounties' Musical Ride, a horse-and-brass-band extravaganza that showed up at fairs and rodeos across the country. The Ride was popular, so there was always an outcry. The Government never could quite bring itself to axe it, and somehow sparing it always seemed to mean that the rest of the spending cuts never happened either. Canada eventually got out of its fiscal hole in the 1990s, thanks to a prolonged period of strong GDP growth triggered by low interest rates and an undervalued dollar. The economy grew out of the problem, so the Musical Ride may have saved quite a few worthwhile worthwhile spending programmes.

This is not to say that there are no spending plans in the UK that should be considered for sacrifice: the Olympic money pit (how are we ever going to build the damned thing if all the Eastern Europeans go home?); the ID card scheme that nobody likes and that probably won't work anyway; the Trident Missile replacement (if we want to confound our enemies in the future, we can just sell them some credit default swaps).

Then there's Prince Andrew, Duke of York and supposed trade ambassador. Conspicuous consumption at other peoples' expense is just so last year. Maybe he can be our equivalent of the musical ride -- though I'm not sure there'd be much public outcry if Gordon Brown cut up his credit card.

Iceland meltdown

People falling over each other to boost returns by taking on risks they don't understand, then looking to governments to bail them out. Investment bankers making dodgy housing loans? No, British savers sticking their life savings into Icelandic banks.

It looks as if their gamble is going to pay off, too. The UK government has announced that it will make sure that all investors in Icesave, owned by Landsbanki, get their money back. Two other institutions operating in the UK, Kaupthing and the weirdly-named Heritable Bank, a sub of Landsbanki, have had their deposits taken over by ING.

I can't say I'm happy about this. The risks of putting money into banks you've never heard of in a country with the same population as a mid-sized UK city, paying improbably high rates and with dodgy deposit insurance, should have been evident to anyone. Sadly, the money sections of the weekend newspapers regularly touted these as the best deals available -- even last weekend the Sunday Times was recommending deposit accounts with both Kaupthing and Heritable.

The Icelandic economy is a huge shell game. I recall being amazed when West Ham FC was bought by an Icelandic billionaire "biscuit manufacturer". Just how many digestives do you have to sell to a country of 300,000 to become a billionaire? The banks used funding from investors around the world, including UK savers, to make monster loans to biscuit boy and his ilk, who then used the money to buy stakes in a wide range of foreign companies, including some of the biggest names in UK retailing. (They even own Woolworths, Lord love 'em).

There's nothing illegal about this, but it beggared belief to think that Iceland's government could properly regulate a banking industry that had slipped its leash so spectacularly, let alone stand behind it when things got rough. Sure enough, Iceland's government has blithely told Alastair Darling that it will do nothing to help Landsbanki's UK customers -- it even seems likely to renege on the relatively limited amount of deposit insurance that it was supposed to provide, leaving the UK treasury on the hook for the whole lot. The UK is planning to sue Iceland, but as the country is effectively bankrupt, I'm not sure what good that will do. Russia is reportedly stepping in to help Iceland with a loan, which doesn't exactly surprise me, given my suspicions of what's been behind the explosive growth in Iceland's banks.

I suppose the Uk Government feels that having bailed out savers with Northern Rock and Bradford and Bingley, it has to do the same for the Icesavers. I'm not sure why it feels it owes loyalty to people who've shown no loyalty to the UK banks, but maybe that's old fashioned of me. At the very least, I hope that when the dust settles the Government ensures that this can't happen again in the future. No longer should spivvy banks be allowed to offer online deals to savers while making no contribution to the deposit insurance scheme. It would also be nice if the newspapers stopped giving these characters free publicity every week, but I guess we shouldn't expect miracles.

Dail bail deal fail??

The Irish parliament, the Dail, has rubber-stamped the Government's plan to insure all deposits in six major Irish banks for the next two years. The deal has caused ructions all over the place. The EU is complaining that it wasn't consulted. It is investigating whether the guarantee constitutes illegal state support, in which case Ireland might face financial penalties. Non-Irish owned banks operating in the country are complaining that they are being discriminated against. Banks in the UK are worried that savers will move money into the Irish banks in order to take advantage of the guarantee, as the UK itself only guarantees £50,000 per depositor, just increased from $35,000. There are signs this is indeed happening. There is even disquiet in Ireland itself, with unions and the political opposition arguing that the Government should not have given the banks a blank cheque.

I have more than the insured limit in a UK bank, but I'm not tempted to move any money to Ireland, because I'm not sure that the Irish Government's guarantee is worth the paper it's printed on. The total value of the guarantee amounts to about three times Ireland's annual GDP. Could the Government ever make good on its guarantee if push came to shove?

It's unlikely that all the banks would fail at once -- though the guarantee proposal reportedly came about because there were fears that two of the six would go under this week, so nothing's impossible. Let's suppose that just one of the six failed and that its deposits accounted for 50% of Ireland's GDP. That's still a huge amount of money to borrow. I don't just mean it's a lot to borrow quickly. It's a lot to borrow, period. By way of comparison, years of diligent overspending by the UK Government have resulted in a national debt just above 40% of GDP. It would take Ireland a long time to raise the 50% of GDP it needed to pay out all the depositors. The consequences for its national credit rating of even trying to do so would be disastrous.

And here's the real fly in the ointment: Ireland can't ask its central bank to give it a quick hand by printing money. As a member of the Eurozone, Ireland has given away that power to the ECB. Given the chilly reception that the EU has given to the guarantee scheme, not much help is likely from that quarter.

The guarantee has given Irish bank shares an instant boost and eased the liquidity crunch in the short term. If I was an Irish bank depsitor, though, I'd be praying that I never had to call on the Government to stump up the dough.