Is the great financial crisis over? Global stock markets (those of the Middle East aside) certainly seem to think so. It looks like the Federal Reserve does too: last week it announced that some of America’s banks are going to be allowed to start paying dividends again. That’s something you’d think they wouldn’t do if they were still short of money.
Unfortunately, according to Arbuthnot’s James Ferguson, you’d think wrong. Ferguson points out that, while the big banks might have slowed the rate at which they are realising losses on bad loans, that doesn’t mean they haven’t got piles of bad loans left. Instead, “if history is any guide”, a credit crisis such as this leaves “a legacy of elevated loan losses for several years after impact”. And there are plenty of signs that it is the same this time around.
One of the odd things that happens after a credit crisis is bad loan ‘evergreening’. Banks need to reduce their loan books to get their capital adequacy ratios back in order. But they can’t get rid of their low-quality loans (they need to keep rolling them over so no defaults turn up). As a result, they end up reducing their good loans instead. This looks slightly counterintuitive from the outside (bank in trouble reallocates its business away from good-quality assets towards lower-quality assets) but it makes sense for the bank: it buys it time to run down the bad loans slowly and earn its way out of trouble.
It also offers an easy way for dogged bad bank chasers such as Ferguson to see to what extent “loss recognition is lagging reality”.
So, are the US banks evergreening? Probably: the lowest-risk category in the US – commercial and industrial loans – has shrunk by 20%. That’s more than any other category and double the average for all loans. But which areas have seen the least contraction? Yes, it is the really risky areas – residential and commercial mortgages.
You’d think that if a bank really wanted to clean up its loan book, it would start by dumping loans against the worst assets (houses) – note that new home sales in the US fell 17% to a record low in February and that prices have started double dipping too.
However, that is not what is happening. There is, says Ferguson, “clear evidence” that the big US banks have been forced to evergreen their loan books, dumping good loans and hanging on to bad in their efforts to contract credit.
This matters. Because even as markets celebrate the apparent return to health of the banks, “their very actions can be interpreted as evidence of ongoing solvency issues”. That really isn’t going to be helped by letting them pay out in the form of dividends what little spare money they do have.
Still, the fact that the US banks might still be insolvent is competing with a lot of other things to be at the top of my worry list at the moment.
There is a government collapse and impending bail-out in Portugal. There is the supply shock in Japan, now spreading itself around the world – computer chips have spiked in price, for example, and car prices are sure to follow. There is the oil price – up 60% since mid-2010 and probably heading higher as tensions simmer all over the Middle East. Let’s not forget that nothing causes a recession quite like a huge spike in the oil price.
Then there is the fact that the second wave of quantitative easing (QE2) that is really propping up markets – is expected to come to an end in June.
I’ve been less cautious than usual on equity markets over the past six months, but I’m beginning to feel that the rather premature resumption of dividends in the US financial sector might be a sign that I should revert to my customary bearishness.
● A quick word on one of the micro points of what I think was a pretty good Budget: George Osborne’s change to the way bulk buyers of property will pay stamp duty. Instead of paying it as one rate on an entire portfolio of properties, they will now pay the rate suggested by the median price in the portfolio. So if an investor buys five flats for a total of £1m, they won’t pay 4% (soon to be 5%) stamp duty, but 1%, so £10,000 rather than £40,000. This has been seized upon by many as another feeble attempt by the government to prop up UK house prices. It might, of course, be partly that (the government is clearly as obsessed with prices as the rest of us).
But there is more to it. Having to pay weirdly large amounts of stamp duty has been one of the things putting institutional investors off buying into our private rental market. A change might encourage them in. Given how much we need a good-quality private rental sector – 17% of the UK population rents privately and 40% of UK private rented accommodation is considered “non decent” – that’s got to be a good thing.
• This article was first published in the Financial Times