It’s been an astonishing 48 hours. Lehman Brothers, is in administration. Merrill Lynch, once Wall Street’s most iconic investment bank, has been swallowed by Bank of America. And AIG, the world’s largest insurance company is apparently on the verge of bankruptcy. Clearly this isn’t good news. But just how bad is it?
What does the current turmoil mean for UK savers?
Nothing good. It’s hard to see any retail deposit takers in the UK actually going under – Gordon Brown’s in enough trouble as it is without letting those of us who have managed to save any money over the last decade lose it. But nothing is impossible. At one point yesterday shares in HBOS, the UK’s biggest mortgage lender, were down 30%. A year ago they traded at £10. Today you can pick them up for well under £3. The management has issued a statement saying that HBOS is a “strong bank.” But how can we know this for sure? As Alex Brummer says in the Daily Mail, “it is the lack of credible and verifiable information about the health of the balance sheets of major banks around the world, including our own high street lenders, which is so terrifying.” The immediate worry is the way in the which the coming fire sale of Lehman assets – and those linked to the still collapsing US housing market in particular – will push down prices of these assets and force UK banks into further write downs of their own. Barclays and RBS, both have exposures to similar assets.
Anyone concerned about their savings might want to move them into either an NS&I account or a Northern Rock account. Both are 100% government guaranteed. Technically up to £35,000 worth of savings is guaranteed elsewhere but the scheme that is supposed to come up with the cash is not pre funded – i.e. if something really does go wrong the odds of you getting your money in a hurry aren’t particularly good. For more on this, see: Are you covered by the FSA safety net?
But even if no banks go bust, the news still isn’t particularly good for savers. It is increasingly clear that inflation is not the real problem facing the global economy. Instead recession is. That means that interest rates are more likely to fall than to rise over the next few months. Indeed, as inflation expectations have fallen in the last few weeks, the rates on fixed rate savings bonds are already on the way down. In the last week says Moneyfacts.co.uk, it has seem 30 changes to fixed rate bond with most involving either a cut in the interest rate or a complete withdrawal of the product. The trend should reverse again – the more banks struggle to borrow from each other the more they need depositors – but with official interest rates falling it is unlikely that it will be as easy to get 7% on your money over the next six months as it has been over the last six months.
And UK investors?
Again, nothing good. The FTSE fell over 4% on Monday and was down by another 1.8% by midday on Tuesday. Overall the UK market is off 20% so far this year. And even if you aren’t directly invested in global equity markets odds are your pension is. Most of us don’t have defined benefit pensions any more. Instead – to the extent that we have anything at all and unless we work in the public sector – we have pensions linked to stock market performance. So with every market fall our retirements look less comfortable. There is a view that this huge bankruptcy (the largest ever in the US) might mark some kind of turning point in the market. We aren’t holding our breath. Let’s not forget that back in April Lehman’s CEO told the market that “the worst” was over. It wasn’t. Christopher Wood of CLSA, in a note yesterday told clients that he sees another $1trn odd in bad debt surfacing before the credit crunch is done with the banks.
All this means that the banking sector is turning in on itself fast – rather than lending money to the rest of use to oil the wheels of the economy it is focusing (quite rightly under the circumstances) on preserving capital. That means credit is scarce. And without credit economic growth grinds to a halt. Jeremy Warner puts it in the Independent: “less credit equals less money equals less business.” Which of course equals less economic growth. And unemployment. And, in the end lower corporate earnings and share prices. Stock market bulls are great ones for “looking across the valley:” – they think we should be thinking about the return of the good times and pricing those in rather than focusing on the bad times. If we were heading for a short and shallow recession that might make sense. But we aren’t: this one will be deep and long. Right now the valley’s too big to look across.
And mortgage holders?
Nothing good. Various mortgage providers have announced cuts in their rates and arrangement fees over the last few weeks (the average fixed rate has fallen from over 7% in July to 6.4% now) but the Lehman’s debacle is likely to make the wholesale money market jitters intensify all over again. Yesterday the Libor rate – the rate at which banks borrow from each other – jumped from around 5% up to more like 5.5%. That’s down from the peaks of well over 6% last year but moving in the wrong direction. So, while those with mortgages that track the base rate might have cause for cheer in the coming months, in general it is likely that mortgage rates will soon be on the way back up again. Our advice? Don’t buy a house. The less available credit there is the more prices will fall.
And employees of Lehman’s?
They’re the worst hit. 30% of Lehman’s was employee owned so they’re definitely losing their savings. Dick Fuld himself poured most of his huge bonuses (we’re talking eight figures here) into Lehman shares. They’re also unlikely to get paid at all this month or to find new jobs in a hurry. No one in the City is hiring and they’ll be competing for work with the many thousands already let go from other institutions and presumably in the not to distant future a large number of the thousands currently working at Merrill Lynch (there are bound to be job cuts as the Bank of America takeover shakes down). There’s also a nasty rumour doing the rounds that the bonuses ($5.7bn worth) received by Lehman’s employees in 2007 might be at risk. According to www.nakedcaptialism.com, if, as is possible, Lehman was trading insolvently in 2007 they could be classed as “fraudulent transfers” and clawed back by creditors. And worst of all, according to Moneymarketing.co.uk there are hefty deficits in the Lehman’s UK based defined benefit pension scheme so they can’t even look forward to an acceptable retirement.
It’s hard to feel sorry for people who have been making whopping – and generally undeserved – bonuses for a decade but it’s worth remembering two things. First most of the 4500 who are losing their jobs are not bonus boys but admin staff receptionists and cleaners. And second, when thousands of highly paid professionals turn into unemployed people there are always trickle down effects. That’s not good news for any of us.