This time last year, most people thought interest rates would have risen by now. The consensus forecast was for around 2.5%. So much for that. On Thursday, the Bank of England’s Monetary Policy Committee decided to leave the Bank rate at 0.5%.
It has been 0.5% for more than two years – so long that people appear to have forgotten just how extraordinary it is. I have printed out and stuck up on the wall beside my desk a chart sent to me by the analysts Church House Investment Management. It maps the Bank rate or equivalent back to 1694. And it ensures that I don’t forget what extraordinary times we live in, by showing that the rate has never been this low before. Never. Take a look at the chart here.
Over the last 300-odd years, the floor for the Bank rate has been 2%. That’s four times higher than our current rate. This is something worth keeping in mind.
Why? Because if you remember that rates are at an all-time low, and have been for more than two years, you won’t get conned into thinking that anything in the UK, or indeed the global financial system, is normal when it just isn’t. You also won’t get seduced into buying shares in any of our big banks.
UK banks analyst Jonathan Pierce left Credit Suisse this week. On his way out, he sent a closing email to his clients – posted by Neil Hume on FT Alphaville. In it, he noted that this is a time “of considerable uncertainty” (something of an understatement) and pointed out why.
His particular concern is “tail risk in bank credit portfolios”: that the banks have rather more problems with their loans than they are admitting to.
I’ve written before about the way that UK banks appear to be dumping good loans but rolling over bad loans in order to make good their capital ratios. They need to have fewer loans on their books but they can’t get rid of the bad ones without writing them down – which they clearly don’t want to do – so they dump the good ones instead.
However, Pierce chucks an interesting number into the mix. If things are getting so much better, he says, “why are there £110bn more interest-only mortgages today than in 2007, despite lower rates and tighter new lending criteria?”
The obvious answer is that, to avoid having to take losses on them, banks are converting the repayment mortgages of homeowners in trouble into interest-only mortgages. That cuts their payments and makes it less likely they will default in the short term. It also means their loans can still be counted as ‘good’ loans.
The idea that the banks all have problem loans that are not officially recorded is not new. But, again, we shouldn’t get so used to the fact that we forget that its scale is utterly abnormal.
A private-equity friend tells me of one of our megabanks coming to his team to try to sell £1bn-worth of second-grade consumer debt. The bank had valued it at 85% of face value. His team verbally valued it at 35%.
They were asked not to submit a bid: as far as the banks are concerned, if you don’t acknowledge something, you can just keep kicking it down the road in the hope it somehow stops being a problem. It is always better to delay marking something down than to actually mark it down, particularly if doing so means you end up needing to raise more capital.
My point here is not just that our banks are probably still in a great deal of trouble (even before a Greek default). It is that they remain entirely opaque. We can’t possibly understand their risks. As Fundsmith’s Terry Smith points out: “in an age with complex derivatives and structured products”, most bank risk levels are not only incomprehensible to investors but to management too.
Given the number one rule of investing – if you don’t understand it, don’t buy it – that seems reason enough to steer clear. The truth is that investing in bank shares these days is effectively to invest in a government-sponsored credit hedge fund. And you wouldn’t do that.
But there’s more. So far, banks and bankers have got away pretty lightly from the crisis. That’s not to say they will keep doing so. Right now, not only is our government about as broke as a government can be without actually being bankrupt, but the public now knows there are hordes of people in London earning £1m a year for doing a pretty average job.
That means that the debate about how bankers should be paid, how banks should be taxed and how the sector should be regulated has probably only just begun.
The unpredictability – and likely lower returns – that come with all of this should be the last straw for bank shareholders. If you aren’t out already, now would be a good time to get out.
• This article was first published in the Financial Times