HBOS collapses and there's more to come
by Raphie De Santos
HBOS: Management Gamble Customers Money on Financial Markets under Brown’s Regulatory and Monetary Umbrella
The collapse in HBOS’s share price and its proposed takeover by Lloyds TSB came as result of the bank’s transformation from a retail bank and building society into essentially a bank that traded its’ customers assets on the financial markets.
This flawed and high risk business model was spotted by hedge funds and proprietary traders at the start of 2007.
These investors anticipated a likely freezing up of the credit markets and slowing down of the global economy. The strategy followed by the post merged HBOS in the new deregulated environment was doomed to failure leading to declining profits for the bank and a fall in HBOS’s share price.
The hedge funds and proprietary traders sold shares in HBOS that they borrowed from pension funds and insurance companies, paying a fee for doing this, and expecting to buy them back at lower prices when other investors realised what was likely to happen to HBOS’s business and they too would sell some of their investments in the bank.
None of them expected that HBOS would almost go bankrupt and the share price would fall to less than one pound. The depth of the recession, the crisis in the money markets and the lack of confidence in the banking sector led to that.
HBOS’s Failed Strategy
Instead of following the traditional model of a retail bank and a building society of lending the money its customers had either deposited with the bank or held in current accounts to other customers through loans, credit cards and mortgages it followed a new strategy.
The strategy was to lend out almost half of its customers money to private equity schemes and corporate finance deals. HBOS could charge a higher rate of interest to these clients because of the higher risks of their projects. These projects worked well in an ever growing globally economy but when it became evident there would be some downturn in the economy then the likelihood of these projects all paying off and HBOS being repaid the original loan in full diminished.
Of course the downturn has now become a full blown global recession with the possibility of it turning into a slump then even less of the money lent out will ever be repaid. Half of HBOS’s £280 billion of customers’ money is lent out in this way!
It meant it had to fund its mortgage loan s from another source. It did this from the inter-bank money markets, the so called LIBOR (London Inter Bank Offer Rate) markets.
It was able to do this for a period because the US central bank and the Bank of England, at the start of new millennium, had cut the rate at which they lend to the major banks to historically low levels to help the financial market recover from the dot.com bubble bursting and the recession or the threat of recession. It was the same practice that led Northern Rock into trouble and caused the UK government to bail it out with at the time the largest nationalisation in capitalism’s history.
When these central banks moved interest rates up to counter inflation
and cool the housing and debt markets they caused a freezing of the LIBOR
money markets which has precipitated a global recession. It is this double
whammy which HBOS’s management did not see coming which has brought HBOS
to its knees and has threatened the jobs of ten of thousands of people
across the UK.
Who Is To Blame?
Undoubtedly it is the HBOS’s management themselves who did not see or access the risks of their business model. But it was the Gordon Brown himself who was mainly responsible. He created the financial regulatory framework through the Financial Services Authority (FSA).
It was a neo-liberal piece of legislation that allowed banks to transform their traditional banking activities into global trading and speculative operations with little oversight and policing.
Secondly, he took the setting of interest rates away from the UK government and gave it to the Bank of England’s monetary committee a bevy of ex and current bankers. They then cut rates too aggressively fuelling a credit and speculative investing boom and then put the brakes on too fast without fully understanding the complexity of the beast they had created.
The Short Sellers
The short sellers have been used by all parties involved including the Alex Salmond and Ian Gray to explain why HBOS had to be taken over and not the fundamental reasons we have explained for HBOS business problems.
The short sellers took positions at the start of 2007 and again in August 2007 when the credit crunch increased the problems of funding in the money markets. In the last few months only around 5% of shares sold have been borrowed that is sold short.
The rest of the selling has come from pension funds and insurance companies as they see HBOS as producing poor returns and as result of the failed rights issue. HBOS tried to raise $4bn from its investors through a rights issue. Nobody took them up and the banks that underwrote the issue (insured it) were left with the shares.
HBOS had its £4 billion from these banks but the banks had £4 billion of shares that nobody wanted in a company with poor prospects. The underwriting banks have been unloading these shares on the market by selling them to try and get some of their £4 billion back. Undoubtedly this has driven the price down as these banks have sold over a billion shares at a loss to themselves.
The short sellers have actually helped stop HBOS’s share price going literally to nothing as they have been the only buyers as they close out their short positions and soak up the wave of selling from the underwriting banks, pension and insurance funds.
Solutions to the Crisis
Salmond’s cry is to do our utmost to save as many jobs as possible.
Some comenatators and trade union leaders have welcomed Lloyd’s takeover as saving some jobs.
The merger will undoubtedly led to tens of thousands of jobs looses as there is duplication at bank branch level and in back office operations between the two banks. Lloyd’s adversity to risk will mean that they will run down the corporate and private equity business centred in Edinburgh. This is likely to accelerate after 2011 once the next general election is over.
Salmond's solution of offering to lend £100 billion to HBOS does not recognise that it was the flawed business model of the HBOS was the problem. He wants to use tax payers’ money to help bail out capitalism – a sort of mini version of what the US government is doing.
His other proposed solution is offer corporations lower tax rates that is to allow them to make greater profits at the expense of working people in Scotland. It is a free market policy but the SNP is quite happy to rescue corporations when their projects fail. The danger of this love affair with the free market with state support can be seen by the vultures lurking in the shadows. Two of the largest banks in world – Bank of America and Citicorp -are considering making a counter bid for HBOS. These two US giants will care little about the outcry from Scotland and carry out savage cuts in jobs and working conditions.
Socialists should demand and campaign for HBOS to taken under common ownership and management and turned into a social bank providing social loans and mortgages and funding a social housing programme with no redundancies and the redeployment of staff from discontinued business areas.
Next on the Horizon Royal Bank of Scotland ?
Will RBS be next to go under? Commentators and politicians have tried reassuring us this will not happen. But its share price has fallen dramatically as well. This is because RBS has become a massive treading house being a major counterparty in everything from US sub-prime debt, interest rate swaps, inflation swaps and credit default swaps (CDS).
It has taken massive losses in these positions in the last year needing to raise£12 billion pounds to shore up its capital reserves to act as a buffer against future potential losses. In recent months as the chances of a full blown global recession have become higher the values of CDSs have increased. This has led to large paper losses for the banks that have sold them and was one of the main reasons Lehmans went bankrupt.
As companies go bankrupt then the banks who have sold these CDSs will have to pay out on these contracts. The total payout will be in the regions of one to four trillion US dollars! That is the problem for RBS; nobody knows the extent of their exposure to CDS contracts and what there potential losses could be. They may not have sufficient capital – cash and shareholders funds – to cover the losses. That is why there is a run on RBS’s share price and why it may follow the same fate as HBOS.
We are in danger of losing two of Scotland’s greatest assets to the casino of global finance capitalism. Assets that could have been used for the benefit of all Scotland’s people in socially useful way, it is Gordon Brown and the apologists for neo-liberalism who are to blame.