The Stench of Corruption and Greed Overwhelms Britain's Financial Services Industry

Britain's tarnished financial services industry and banking sector seems intent on bringing about its own self destruction. Over the years there has been a litany of scandals eg:

- endowment mis-selling
- subprime mortgages
- PPI mis-selling
- LIBOR fraud
- NatWest computer meltdown
- Northern Rock, RBS etc etc to name but a few

However, it seems that the industry is determined to add to its list of self inflicted shame and dishonour. Step forward the usual suspects ie; Barclays (a familiar name), HSBC, Lloyds and RBS which have all admitted to mis-selling interest rate hedges to small and medium sized business customers.

Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland have all agreed to immediately halt the sale of complex interest rate hedges to smaller businesses and have pledged to compensate potentially thousands of customers who have been screwed by them.

According to the Telegraph the FSA is of the view that about 28,000 businesses had been sold interest rate hedges.

Another nail in the coffin of the tarnished reputation of the UK's financial services industry.

The financial services industry is now fully immersed in its own self created shit, and quite clearly is on the verge of implosion.

Windfall For RBS

RBS, the "people's bank", will collect a nice little windfall as result of the decision by Goldman Sachs to take a $550M hit to settle civil fraud charges over how it marketed the sub prime mortgage product.

RBS is due to pick up $100M from this, because marketing materials for the Abacus 2007-ACI transaction allegedly contained incomplete information. RBS lost $841M from the deal with Goldman.

However, rumours abound that RBS may sue Goldman for the remaining loss.

RBS In Deep S**t

It is fair to say that the Royal Bank of Scotland (RBS) has placed itself in a very deep pile of s**t. RBS announced today that its losses (due to be formally announced in February) could hit £28BN, partly due to its bizarre decision to spend billions acquiring ABN Amro last year. ABN Amro had exposure to US sub-prime mortgages, and invested directly in the American home loan market.

One wonders quite why RBS thought that this was such a great deal at the time, and whether the board had any real understanding of what was happening in the market.

Gordon Brown chose to vent his spleen on the subject (a political ploy no doubt, but it will resonate with the public), as per The Times:

"Yes, I'm angry about what happened at the Royal Bank of Scotland.

Now we know that so much was lost in sub-prime loans in the US and now we know that some of that was related to the purchase of ABN Amro, I think people have a right to be angry that these write-offs are happening and that these write-offs were caused by decisions that were made about international investments that were clearly wrong investments."

Despite being angry, Brown will increase the government's stake (ie ours) in RBS from 58% to 70%.

I wonder how many of the RBS board will resign for their folly, end eschew generous payoffs?

Silly Money

The Sub Prime Pyramid Scheme Explained

Lehman Collapses

In case anyone has not heard, the Wall Street bank Lehman Brothers has filed for chapter 11 bankruptcy protection, after emergency talks to find a buyer failed.

Lehman Brothers was one of Wall Street's biggest dealers in fixed interest trading, and was heavily invested in securities linked to the US sub prime mortgage market.

The FTSE has fallen 3% on the news. The effect that it will have on UK banks remains to be seen, and will depend very much on their exposure to it.

Ruined Reputations

The US, with characteristic speed and vigour, moved to steady the finances of Freddie Mac and Fannie Mae yesterday.

The LA Times reported:

"Acting to prevent a severe disruption of the mortgage market, the federal government stepped in Sunday with plans for a sweeping aid package designed to bolster confidence in battered home-loan giants Fannie Mae and Freddie Mac.

The Bush administration said it would ask Congress to authorize the Treasury Department to lend Fannie and Freddie more money than current limits permit and buy stock in the two companies.

Also Sunday, the Federal Reserve agreed to permit the companies to borrow directly from the central bank, as investment firms were allowed to do after the near-collapse of Bear Stearns Cos. in March. The money would tide Fannie and Freddie over while the administration and Congress rush the emergency measures through."

This action provides an opportunity to reflect on what the British authorities and Bank of England would have done under similar circumstances. To some extent we already know, using Northern Rock as an example, they would have done very little and it would have been too late.

Our monetary authorities have been proven to be asleep at the wheel and, like rabbits frightened in the headlights, frozen with fear when confronted with a serious issue that needs resolute and muscular action.

As I recently noted, leading British banks have met with the Bank of England to ask for more help in stabilising the lending market; the £50BN injection, made earlier this year by the Bank of England, was simply not enough and the actions taken by the Bank and government since then have been too cautious and slow to have any meaningful impact on the confidence of the banks.

However, let me make it clear, whilst the inaction of the monetary authorities has contributed to this crisis the primary blame can be laid at the feet of our "respected" banks.

They willingly chose to buy and sell toxic sub prime debt from the US, in the hope that they could make a fast buck. The sub prime scheme was a classic pyramid selling scam, so long as you could keep selling the debt on without it crystallising the pyramid would keep growing. However, as with all pyramid scams, there is always an end.

Either the directors of our banks were incredibly stupid and did not know/understand what they were buying/selling (what were the risk and compliance departments doing during this period?), or they knowingly participated in the pyramid scam in the full knowledge that at some point it would collapse.

Either way, the reputation of the banks and those who run them has been ruined; it will take many years for the banks to restore their reputations.

The reputations of the British government, monetary authorities, financial services industry, City of London and banks have all been ruined by this scam.

Lessons will need to be learned and senior people removed from office if trust and confidence are ever to be restored.

US Mortgage Crisis Worsening

There has been a feeling in some quarters that the worst of the credit crunch, brought about by the greed, arrogance and stupidity of the banks was over.

Unfortunately this is not the case. To add to the litany of the banks' failings we must add another, fraud.

Standard & Poor report that the US mortgage crisis will become considerably worse, because the level of fraudulent lending to unsuitable borrowers was much higher than previously estimated.

David Wyss, Standard & Poor's chief economist, is quoted in The Times speaking at a conference in Bombay:

"The panic has subsided, but the housing market has not hit bottom yet. Housing prices won't hit bottom until next summer and the losses won't peak for another two years, until 2009. We are not halfway through this crisis yet.

We underestimated the extent to which fraud was occurring in the industry. It looks [as if], based on some surveys that had been done, the extent of frauds increased sharply in 2006."

The frauds increased as lenders looked for new customers, having sold all the mortgages that they could to legitimate customers.

In effect the sub prime mortgage industry was nothing more than a pyramid (Ponzi) scam. In order for it to work the banks had to keep selling more mortgages in order to boost their commissions and to maintain their cash flow as other sub prime mortgages, sold earlier, began to default.

These toxic debts were then bundled with good debt and sold around the world to other banks and financial institutions, who deluded themselves that they knew what they were doing.

Hence, as the situation in the US worsens, the effect will be felt here as the banks that were stupid enough to buy these useless products take the hit.

Regrettably the Bank of England has chosen to ignore the economic Tsunami that is heading our way, and has sat on its hands at yesterday's MPC meeting and kept interest rates unchanged.

By the time the Bank of England wakes up to this, it will be too late.

The $51M a Day Write Off

Congratulations to HSBC who have so managed to mire themselves in the disaster of the US sub prime market that they are now forced to write off $51M per day in bad loans.

HSBC announced that they wrote off $11.7BN in bad loans last year, mainly from US sub prime defaults, and that this situation was still deteriorating.

Stephen Green, HSBC's chairman, said:

"We're not in a position to say we've turned the corner or passed the worst."

The greed, arrogance and stupidity of the banks have brought about this mess. Regrettably the people who will suffer the most are the poor saps who had these loans foisted on them in the first place, and those who are more financially sound who now seek to borrow money, as the banks retrench from the loans market.

Needless to say, the senior management of the banks do not intend to allow themselves to suffer. Without any hint of irony, HSBC released details of a new executive reward scheme which will allow bonus awards of up to 400%.

Michael Geoghegan, the chief executive, could in theory "earn" a bonus of up to £4M on top of his base salary of £1.07M. He earned £3.5M last year.

Another, unnamed, director of HSBC managed to earn £10M in pay and bonuses last year.

Nice work if you can get it!

Banks - Who Trusts Them?

Given the recent scandals involving SocGen and Credit Suisse, and the massive write downs being posted by banks as a result of their reckless gamble in the US sub prime market, how can anyone (borrowers, savers or investors) seriously trust them anymore?

The Failure of The UK's Financial System

Those of you who missed last night's Dispatches documentary on Channel 4, about how the banks have gambled away billions of pounds of our money, should access a re-run of it as soon as possible.

In the programme, private equity financier Jon Moulton laid the blame for the current financial meltdown firmly at the door of the banks that gambled billions of pounds away on high risk sub prime mortgages in the USA.

Northern Rock, unsurprisingly, was mentioned more than few times. Moulton, aside from blaming the then board of this bank for destroying it because of their greed and arrogance, also directed his ire towards Gordon Brown.

Who he stated, quite correctly, wrecked the financial regulatory regime when he took away the Bank of England's responsibility for monitoring and regulating financial institutions and the markets in 1997 and split it up across:

-The Treasury
-The FSA
-The Bank of England

Moulton noted, as I have done many times on this site, that the tripartite regime's major failing is that no one is actually in charge; as was self evident when Northern Wreck imploded.

Moulton castigated the three members of the regime for their incompetence, and for failing to heed the obvious warning signs of the financial storm heading our way He warned that worse is to come, as the banks announce their results over the coming weeks.

Indeed, we see today that Barclays profits have been hit by a massive £1.64BN write down emanating from their failed gamble in the US sub prime market.

Will things improve?

In the short to medium term, no:

1 Banks and other financial institutions are taking massive losses, and continue to draw in their lines of credit. In other words, they will stop lending to each other and to the ordinary person in the street. The economy will take a very severe hit.

2 As long as Gordon Brown is Prime Minister, and that looks likely for the next year or so, the current failed tripartite regulatory mechanism will not be changed for the better. He is the arrogant architect of this failure, but will never admit to it.

As stated, watch the Dispatches documentary on Channel 4,

French Lessons

The recent SocGen scandal whereby Jerome Kerviel has been fingered by directors of Societe Generale, one of France's most banking prestigious institutions, as being solely responsibly for losing Euros5BN has provided a little "light relief" for other banks and investors caught up in the turmoil in the world's financial markets.

However, the matter does raise some rather intriguing questions about how Soc Gen has handled itself during this crisis.

Firstly, and most obviously, how was a relatively junior trader able to get away with such large scale deception over a long period of time?

From January 7th Kerviel had exposed SocGen to the tune of Euro50BN.

How is it that no one noticed this until, allegedly, Friday the 18th?

Reports now indicate that SocGen had seen warning signs much earlier. A classic warning sign of fraud, is an individual who never takes a holiday. Kerviel had not taken a vacation for over 8 months.

Where was the bank's internal audit department?

Why didn't SocGen act on these warning signs?

How is that one lowly trader acting on his own could evade all of SocGen's internal controls, designed top prevent frauds such as this?

SocGen claim that he was working alone.

Yet is this plausible?

Who else helped him?

Another intriguing factor is the timing of the SocGen unwinding of its positions. They unwound their positions on Monday 21st January, the very day that world markets began another freefall, and the day that the Fed made an emergency rate cut of 0.75%.

It seems that Kerviel and SocGen added to the woes of the financial markets, and may have been responsible for pushing the Fed into an emergency rate cut.

Aside from losing Euros5BN, as a result of this fraud, on the same day that SocGen announced this loss (Wednesday 20th January) they also announced losses on sub prime deals of around Euros1.5BN. Note: SocGen are taking the Euro5BN loss to their 2007 results.

How very odd that they combined the announcements!

Was there really a fraud there?

Is it possible that Jerome Kerviel is being made the scape goat for some really lousy legitimate trades made by SocGen?

The timing of the announcement is also raising a number of questions, not least why did they not announce this on the day/weekend that they discovered the fraud?

Indeed, President Sarkozy was kept in the dark for three days over this fraud. He was not told until Wednesday. Suffice to say he is not best pleased, and is asking the very same question.

Why keep quiet for so long over this matter?

The accounting treatment of the losses, taken to the 2007 results, also does not stand up to scrutiny. Why were they not taken to the 2008 results, the year in which the losses were made?

Clearly we have much to learn from the French about how to treat such issues!

It is clear that a lot more is going to come out in the next few days, those in SocGen who think that the worst is over should think again.

Others are going to be joining Kerviel, as he "helps police with their enquiries".

Daniel Bouton, SocGen's chief executive, and Christian Noyer, the governor of the central bank, take note.

The FSA's Light Touch

The BBC's Panorama programme last night exposed the precarious foundations of Britain's housing price bubble and credit boom, as it highlighted a number of "criminally" negligent cases of mortgages being provided to people who had no hope of ever affording them.

One such case being that of Emmanuel Blango, a psychiatric nurse who earns around £25K per annum. He was awarded a a sub-prime mortgage from the Alliance and Leicester for £300K, and another mortgage for £200K from Platform which is part of the Britannia Building Society.

Unsurprisingly Mr Blango is having trouble paying the interest, and has had his second flat repossessed.

Panorama noted that around 70% of the 7000 repossessions over the last 3 months are down to sub prime lending.

The reasons for this boom in "risky" (for want of a better word) lending are as follows:

• The commissions earned by the mortgage salesmen, who target the financially naive, are distorting their "ethical" principles when they advise their clients.



• The lax checks performed by banks and building societies on mortgage applications.



• The bundling of the debt by City institutions for immediate resale, thus paying off the first lender and eliminating the original lender's risk.



• The light touch of the FSA in regulating the market and enforcing its rules.

The extent of sub prime mis-selling is reminiscent of the endowment scandal of the 1980's.

It is regrettable that despite the lessons that the FSA should have learned over the endowment mis-selling scandal, it appears not to have taken them on board in its regulation of the sub prime mortgage market.

The UK faces the very real threat of a housing price collapse, and economic chaos, as the number of defaulting sub prime mortgages increases.

Why has the FSA allowed this to happen?

Clearly the FSA, in its current form, is not fit for purpose.

Swiss Banker Speaks Out

The Swiss central bank chief, Jean-Pierre Roth, lashed out at the US economic system in an interview on Sunday. Roth was speaking about the ongoing credit crunch, that has caused volatility in the world financial system.

Roth said:

"Something unbelievable happened.

We're certainly not at the end of the story with developments in the US mortgage market. The source is bad loans.

People there who had neither income nor capital got credit with very attractive conditions that could only be tightened with time.

And now we're seeing that there isn't a market for such papers. Now reality is striking back. That leads to massive losses and there will be victims.

Fair comment, except that it should have been clear to senior bankers around the world that the sub prime market in the US was high risk; as such, to say that this was "unbelievable" doesn't ring true.

Another Silver Lining

Further to my article yesterday, about lawyers benefiting from the current "credit crunch" caused by the US sub prime fiasco.

There is another silver lining, this time for those holding mortgages in the UK.

The "credit crunch" has left banks and other lenders unwilling to lend money to each other, as they are afraid that there may be hidden losses.

This has led to a squeeze on the availability of loans, and is threatening to cause total market "seizure".

As such, the Bank of England will eventually be forced to reduce interest rates. Most certainly in the short term it will not increase the rates, as had been widely predicted less than a month ago.

Therefore, ironically, those who hold debt may find themselves in a less worse position than those who have invested their money in funds, pensions and equity.

Funny old world, isn't it?

The Silver Lining

Whilst investors and bankers gnash their teeth as they suffer the fallout from the sub prime mortgage fiasco in the US, there is one group of people that will be rubbing their hands - lawyers.

It seems that the liquidity crunch, brought about by the sub prime fiasco, has exposed another problem. That of the ratings applied by so called "professional" investment firms and hedge funds.

I understand that some companies given AAA+ ratings are in fact not quite as "blue chip" as their ratings would suggest, and that money put into these companies has in fact been lost.

The question therefore arises, why were they given AAA+ ratings?

Seemingly the research done by some "professional" companies that provide ratings was not as thorough as it should have been.

The lawyers will have a field day when people wake up to the fact that the ratings are in fact wrong.

As said, there is always a silver lining!

FSA To Warn on Sub Prime Market

The Financial Services Authority (FSA) will this week issue a warning about the UK's subprime mortgage market, which lends to people with poor credit records.

The FSA will criticise both lenders and brokers, when it publishes the results of its investigation into the mortgage market.

The FSA has reportedly found poor record-keeping at some brokers, showing that they are unable to demonstrate that they sold customers mortgages that were suitable for them (echoes of the endowment mortgage scandal, don't these people ever learn?).

The FSA's report comes amid the continuing collapse in the US subprime market, partly due to a sharp rise in borrowing costs in the past three years.

Another nail in the coffin of the tarnished reputation of the UK's financial services industry.

US Sub Prime Infection Spreads To UK

The fallout from the US sub prime mortgage collapse has spread to the UK. Cambridge Place, the London fund manager, has been forced to close its $908M listed fund as a result.

Cambridge Place said that it would sell the assets of Caliber Global Investment, a London-listed fund, after suffering a net loss of $8.8M in the first quarter of this year.

Caliber has about 60% of its investments in the US, mostly in mortgage debts rated BBB or below. These are securitised tranches of mortgages given to people with impaired or nonexistent credit histories.

Not surprisingly such loans are high risk and carry an interest rate premium. The collapse in house prices in the US has caused borrowers to default on their payments, thus causing a knock on effect affecting those funds that bought the securities.

A sneeze in America can give Britain a very nasty cold.

Mortgage Effectiveness Review

The Financial Services Authority (FSA) is to up the ante on its investigation into the UK mortgage market, with a new focus on those consumers considered most at risk from mis-selling.

This will be the second stage of the FSA's Mortgage Effectiveness Review, and will focus specifically on sub-prime lending and lifetime mortgages.

This shift in emphasis comes at a time when there is increasing concern that lenders are engaging in irresponsible lending to consumers, who might not be able to afford repayments if circumstances change.

These doubtless would be the same lenders who gorged themselves during the endowment mortgage heyday in the 1980's.

Vernon Everitt, the FSA's director of retail themes, said:

"Although there are signs that the UK housing market is coming off the boil, the question is, to what extent are consumers prepared for the consequences of a weaker economic environment?

With recent base rate rises, the ratio of payments to income is creeping up and many fixed-rate deals are coming to an end, potentially increasing the vulnerability of both borrowers and lenders.

So given this climate, all the players in this market clearly need to think through their decisions very carefully indeed. We are, as you would expect, taking these issues seriously and have made debt and affordability one of our priorities.

Initially we are looking at this in respect of more vulnerable groups: the sub-prime market, interest-only mortgages and those taking a mortgage into retirement.

We want to make sure that consumers are not being offered sub-prime rates when they could be eligible for much better prime rates."

In other words, the level of consumer debt, and the rise in the housing market, make some people desperate and vulnerable to the actions of less than scrupulous lenders.

The question is, what does the FSA intend to do once it has completed its review?

Happy Birthday FSA

The financial Services Authority (FSA), as it celebrates its 5th birthday, has come under a barrage of criticism.

Roy Leighton, chairman of the Financial Services Practitioner Panel (FSPP), has called for a clear-out of "dead wood" in the FSA.

A report by the FSPP said that overall industry satisfaction levels with the FSA had shown little or no improvement in the past two years.

The report calls for personnel changes, and claims that some of the less senior officials had a box-ticking approach and an unhelpful attitude.

Leighton said:

"There is undoubtedly some dead wood there.

They're not able to make the qualitative decisions [necessary in a principles-based regulatory regime] when they have been used to box-ticking."

To add to the FSA's woes, John Gummer MP and chairman of AIFA (the Association of Independent Financial Advisers), also "put the boot in" so to speak.

Gummer was speaking at the annual AIFA dinner on Thursday night. He used his speech to criticise the FSA for unfairly undermining IFAs in a recent press release.

He said that an FSA statement on advertising mortgage promotions in the sub prime sector gave the impression that IFAs mislead the public more than banks or lenders.

Quote:

"When we investigated, we found that the incidence of failure in large scale operations (banks) was twice as high as it was in IFAs and this was not mentioned in the FSA press release."

Adding that the FSA had given the impression that there was "something wrong with IFAs when their research showed the opposite to be true".

Warming to his theme, Gummer went on to accuse the FSA of failing to meet a legislative requirement to consult industry before setting down new rules or guidelines.

He said that the principles-based regulation was a primary cause of this problem and confusion and shirked fundamental guidelines put down by parliament, that "the regulator must be regulated by proper regulation".

Stephen Bland, director of the FSA's Small Firms Division and Retail Intermediary sector leader, said:

"We of course accept that AIFA will have strong views on subjects close to their members' hearts and that they are perfectly entitled to say them. On this occasion, however, we felt that the comments did not display a full understanding of where the FSA is coming from, which is disappointing given the frequent contact we have with them."

Happy Birthday FSA!