Wednesday, 19 March 2008

Rumour, Rumour

After almost six months of credit difficulties, central banks are no closer to stabilizing financial markets. If proof were needed, today's FT Alphaville was full of half-baked and shocking rumours about banks.

Here is just a selection of what was on offer to the credulous reader:

"No foreign travel for Bank of England senior staff over Easter, supposedly because a major UK clearing bank is in trouble".

"Swiss government is preparing a bailout of UBS".

"BNP has no interest in a merger with SocGen-BNP merger because of further as-yet uncovered problems".

On the face of it, none of these rumours appear to be true. Nevertheless, these days financial markets are willing to consider any crazy story. This tells us how bad things have become. With Bear Stearns going under in just four short days, and the Fed bringing rates down to just 2.25 percent, there is a growing sense that anything could be true. This only weakens the financial sector further, since banks are now vulnerable to any unsubstantiated rumour - a dangerous situation for any leveraged institution.

Why have things become so unstable? How did things get so bad? A large part of the blame must rest with the Fed. These sudden interest rate reductions seem disproportionate and only serve to increase the sense of distress and panic. If the banks are illiquid, the Fed could have injected liquidity while accepting good quality collateral, without turning real interest rates negative.

Contrast the erratic behaviour of the Fed with that of the ECB. The European banks are also deeply implicated in the sub prime mess. However, the ECB kept its nerve. It injected liquidity to Spanish and Irish banks, who are in housing market related trouble, yet at the same time, left rates consistent with keeping inflation under control.

Instead, the Fed cut rates dramatically, weakened the dollar, destabilized commodity markets, and provoked a rapid run up in oil prices. Understandably, inflation expectations are rising, while the risk of a recession has not diminished. As a consequence, their counter-inflationary credibility is rapidly dissipating.

Our own Bank of England seems to be in between these two poles. It has cut rates, but it has not followed the Fed's mad dash to zero. However, UK inflation remains stubbornly high and inflationary expectations are rising. Based on today's MPC minutes, the Bank's resolve does appear to be weak and it would surprise no one if they also succumbed to the Fed's moon-madness.

Above all, central banks need to be credible. That means that people need to believe that they have inflation under control and that they are ready to provide liquidity to cash-strapped but essentially solvent banks. Currently, the ECB comes closest to meeting this test. The Bank of England looks to be very shaky, while the Fed seem to have lost the plot altogether.


Anonymous said...

LONDON, March 19 (Reuters) - Britain's financial authorities made a rare public move to calm jittery markets on Wednesday, saying they were not aware of problems at any UK bank and would investigate share price moves sparked by unfounded rumours.

Despite a 75 basis point cut in U.S. interest rates on Tuesday -- the latest attempt by the Federal Reserve to restore stability after the rescue of U.S. bank Bear Stearns at the weekend -- London markets remained volatile.

HBOS, Britain's biggest mortgage lender, bore the brunt of the rumours, with its shares plunging 17 percent to a record low of 398 pence at one point.

HBOS, owner of the Halifax brand, dismissed the speculation, saying it had an ``exceptionally strong balance sheet'' and continued to access wholesale funding. Its shares pared earlier losses and by 1315 GMT were trading at 462p, down 4 percent.

The Bank of England, which has come under fire for failing to react quickly enough to the near collapse of Northern Rock six months ago, took the rare step of commenting on the rumours.

``No meetings have taken place or been scheduled to discuss problems with any institution in the UK,'' a BoE spokesman said.

The financial services regulator, which has also faced criticism over the Northern Rock debacle, confirmed an earlier Reuters report that it would probe the latest share sell-off.

``We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumours and dealing on the back of them,'' the Financial Services Authority (FSA) said in a statement.

Authorities are concerned that speculators can benefit from wild gyrations in share price and spread false information. Investors can profit by selling shares ``short'' before buying them back later.

Shares in other banks Alliance & Leicester and Bradford & Bingley also both fell over 5 percent amid talk that higher funding costs were heaping pressure on banks facing a UK economic slowdown and more losses on risky U.S. assets. They also pared early losses.

Policymakers showed they have an increasingly watchful eye on the situation.

BoE Deputy Governor John Gieve, whose remit is financial stability, has been replaced by another of the central bank's policymakers at a speech on Thursday so he can stay in London to monitor market developments.

Governor Mervyn King and fellow Deputy Governor Rachel Lomax have also cancelled regional visits this week, as financial market fears heightened after the forced rescue of Bear Stearns.

A BoE spokesman said rumours that King or other senior executives had cancelled a trip to the Far East due to a possible problem were ``complete fantasy,'' however.


Concerns about a slowing economy, exposure to risky assets and high funding costs remain at the heart of the weakness across bank stocks, and interbank borrowing rates nudged higher for a ninth straight day despite the U.S. rate cut.

Northern Rock's crisis was sparked by its failure to raise funds in wholesale markets following a credit crunch and there are worries there could be more casualties.

A spokesman for HBOS said: ``We're a very diversified business with an exceptionally strong balance sheet...We continue to access wholesale markets whenever we feel it is appropriate to do so.''

HBOS shares have tumbled 37 percent this year, compared with a 15 percent fall for the UK bank sector.

The interbank cost of borrowing three-month sterling hit a fresh high for the year on Tuesday, rising for an 8th successive day to 5.97250 percent. Lending has slowed amid worries about counterparty risks, making banks wary about lending to one another.

The cost of insuring HBOS's debt against default also rose on Wednesday, continuing a trend across the sector.

HBOS credit default swaps (CDS) were trading at 265 bps -- meaning it costs 265,000 euros to insure 10 million euros of its debt per year -- up from 250 bps on Tuesday and double its cost at the start of the month and compared to just 7 bps a year ago.

The BoE said on Wednesday it had not made any loans through its standing facility in the previous trading session

Anonymous said...

LONDON (Reuters) - The Financial Services Authority is investigating trading in UK financial stocks after rumours of banking trouble battered shares and led mortgage bank HBOS on Wednesday to a record low.

Market jitters over the past months have been exacerbated since the near-collapse of Northern Rock by persistent rumours of liquidity and funding trouble elsewhere in the UK banking system, hitting other lenders despite repeated denials.

"There has been a series of completely unfounded rumours about UK financial institutions in the London market over the last few days, sometimes accompanied by short-selling," Sally Dewar, the FSA's head of wholesale and institutional markets, said in a statement.

"We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumours and dealing on the back of them."

Josh said...

An implied hint at HBOS problems with this post, perhaps.....

Anonymous said...

Is HBOS failing or not. It is all so confusing. I don't any lines yet....

Anonymous said...

With so much really bad news around at the moment its hard not to become rather fatigued and weary with the whole situation. Three years ago these sorts of rumours would have been incredible now however the incredible is rapidly becoming mundane.


traderboy said...

just look at the long-term chart of HBOS...clearly something is not right there.

If it's this bad while unemployment is low and rates only just going up, I can't imagine what it'll be like when the recession hits and mortgage defaults REALLY start increasing...

Anonymous said...

I'm no expert on graphs but working on the assumption that down=bad HBOS look like they're in for a rough ride.


Anonymous said...

HBOS is not going down, that is it wont be until the govt tell us "it has a solid loan book" or similar...then you need to worry.

Anonymous said...

No HBOS rumours today.