Some blame the financial crisis on a misalignment of interests between banks’ executives, focused on short-term gains, and their longer-sighted shareholders. The problem now is that the goals of owners and managers are too well aligned. Both want to husband capital and lend carefully. That puts them at odds with everyone else.
How else to explain another week of bail-outs, billion-dollar losses and brutal bank sell-offs? Start with the bail-outs. On January 15th the Irish government announced the full nationalisation of Anglo Irish Bank, the country’s third-largest lender. Four days later the British government unveiled a potpourri of measures to stimulate lending, including a guarantee scheme designed to protect banks against losses on bad assets and an increase in its stake in Royal Bank of Scotland (RBS) to 70 percent. On January 20th the French government agreed to provide another €10.5 billion ($13.6 billion) of capital to its biggest lenders. After its predecessor was forced to pump more money into Bank of America on January 16th, the new American administration is working on fresh plans to immunise banks from the effects of their infected assets.
This burst of action comes just a few months after governments shored up the banking system with capital injections and sweeping guarantees for depositors and creditors. Despite the howls of protest today, that money was not wasted. The assurance that governments will not let important lenders fail continues to keep the fear of bank runs and bankruptcies at bay. Credit-default-swap spreads on bank debt have remained relatively static (see chart), at least compared with the pounding that their shares have taken since the start of the year.
Since the fall of Lehman Brothers, default risk has largely shifted from banks to the governments that back them.
That leaves two puzzles to solve. First, if governments have buttressed confidence in the banks’ ability to survive, why the renewed rush to intervene? Second, if governments continue to demonstrate support for the banks, why aren’t shareholders rejoicing? The answer to both questions lies in concerns that not enough credit is flowing. Bankers themselves deny the charge that they are hoarding capital. Jamie Dimon, the boss of JPMorgan Chase, told investors on January 15th that his bank “was making loans all the time”. Analysts at Credit Suisse reckon that British banks have increased their balance-sheets since June.
The problem is that even if individual institutions manage to grow their books, there is still a huge gap in financing capacity to fill. Foreign lenders are under pressure to focus on their home markets. On January 16th America’s Treasury asked the banks in which it has injected capital to provide monthly reports on their lending: it is safe to assume that officials are more interested in loan growth at home than they are abroad. Corporate-bond markets are much livelier than they were but other non-bank sources of finance, such as the securitisation market, remain stagnant.
Replacing this lost capacity would be hard at the best of times. Right now, it is nigh on impossible. Demand for credit is subdued. Losses are surging as the economic climate worsens. Regions Financial, an American regional bank, reported a record $6.2 billion quarterly loss on January 20th on souring property loans. Structured products still have the capacity to wound. Shares in KBC, a Belgian bank, plummeted on concerns that it would take big write-downs on corporate collateralised-debt obligations. Even staid custody banks are finding unpleasant ways to surprise. Shares in State Street lost nearly 60 percent of their value on January 20th as it announced large losses on bond investments (although Northern Trust, another custodian, beat expectations a day later).
In the face of these losses, the natural (and logical) inclination of banks is to hold on to capital, not to run it down further by ramping up lending. Hence the renewed efforts by governments to free up banks’ balance-sheets. Hence, too, the violent sell-offs in many bank shares-the KBW bank index is down by 40 percent this year-as investors fear that the price of further intervention is dilution.
Public ownership may be unpalatable to many but it is just as difficult politically for governments to keep injecting money into banks without wiping out their owners. Tactically, too, the approach of injecting capital in the form of preferred shares rather than common equity, has its limits.With share prices so low, any more capital-raising is bound to be dilutive (thereby reinforcing the urge of investors to sell). And the woes of Bank of America since its acquisition of Merrill Lynch is a further warning for private capital to sit on the sidelines, leaving governments to pick up the pieces. It may not be imminent or desirable but the threat of nationalisation is looming ever larger.