Precipitate falls in share prices in most major markets on Monday, despite approval of the US ‘bail-out fund’ last week, showed politicians and regulators that they had to do a lot more to prevent financial meltdown.
The prices of UK bank chares have collapsed, with the weakest – in terms of capital - Royal Bank of Scotland, tumbling to under 100p on Tuesday, a fifth of its level last year. Reports that several of the big banks had met the Chancellor and regulators to discuss a possible injection of capital into banks by the government spooked the markets even more.
Actually, such a ‘recapitalisation’ scheme would make sense for everyone. Warren Buffett has provided a perfect blueprint. The billionaire boss of Berkshire Hathaway invested $5 billion in preferred stock in Goldman Sachs, in return for which he gets annual interest of 10% and the right to subscribe for a lot of shares in the bank at a big discount. This kind of deal would make sense for UK banks too. They would get a lot of new cash, would be seen as supported by the Treasury, and the taxpayer would stand a good chance of getting payback from the shares as well as from the high interest on the preferred stock.
The problem is that this kind of deal is needed for all the European banks and will only work well if it is coordinated across the major European economies. So far, European politicians have proved incapable of putting such deals together, which gives investors plenty of reasons to remain nervous about European banks.
US problem spills over
By now you may be wondering why it is European banks that are in trouble when the toxic sub-prime stuff is all American. It turns out that the European banks were even more gung-ho in expanding their lending than US banks, using lots of ‘wholesale’ funding from the money markets that has now dried up, and need more capital in order to absorb likely loan losses.
Regulators were – you guessed it - asleep at the wheel, and only recently created new capital rules for banks that would in principle allow them to lend even more against the same capital. And the regulators allowed all sorts of stuff to be included in capital, so that banks have operated with smaller and smaller amounts of real share capital – yet when the going gets tough, it’s only this form of permanent capital that anyone trusts.
Until we get some firm proposals on a pan-European solution to the banking crisis, stock markets will remain mad, bad and dangerous. If we don’t get a solution, today’s low prices are right, because we’ll have a very deep and nasty recession. If we do get a solution, share prices could rise sharply, but one thing is for sure: the stockmarket will be a rollercoaster ride for which you really do need nerves of steel.
