Wednesday, September 17, 2008

Bank Sector Looking Rough

Bleak outlook for banks
By Michael Hewson
Wednesday 17 Sep 2008

In an article written on 27th August I pondered whether there would be more bad news from the banking sector and the likelihood of the industry remaining under pressure. It appears that my fears were well founded.

The wheels continue to come off and I can’t really say that it has come as a surprise. Lehman has filed for Chapter 11 bankruptcy, while Merrill Lynch has been bought by Bank of America and AIG is currently seeking emergency funding – if they fail they could well be next.

Bank shares will continue to have limited upside until the full extent of this crisis becomes apparent. There was never really any possibility that US treasury Secretary Henry Paulson would extend the help given to Fannie Mae and Freddie Mac to Lehman and this resulted in any possible interested parties in walking away from a deal. The problem now is to establish the number of banks exposed to Lehman. The Federal Reserve is expected to try and help banks exposed to Lehman’s by using a wider range of collateral to borrow funds. However, I can’t help thinking that this could be akin to sticking a band aid on a shrapnel wound.

It’s difficult to estimate what impact Lehman’s failure, or that of any other bank, will have on future write-downs. This in turn will make the remaining banks more reluctant to lend to each other less more of their number go the same way as Lehman, which will serve to tighten up the credit markets even further.

Due to the complexity of the financial instruments involved it will be a very long time before anyone can hazard a guess as to the likely cost of all this with respect to the remaining banks and their indebtedness towards each other. It could well be that we will see more banks fail over the coming months. Former Fed chief Alan Greenspan certainly seems to think so, and I believe we should be very concerned at the exposure of some of our own financial institutions and hope that they have been a little more prudent than their American counterparts. Certainly judging by the share price declines over the past couple of days in RBS and HBOS the market is very nervous about their balance sheet exposure.

The wider impact on the UK economy cannot be underestimated with the resulting job losses that will ensue both here in London and overseas from the fall-out from these events. The CBI is already predicting 2 million unemployed by the end of 2009 and inflation is continuing to edge towards 5%. Food prices alone rose a record 14.5% and energy prices have risen on average over 20% over the past 12 months! If inflation continues to hold at these levels it is highly unlikely that the Bank of England will be able to ease monetary policy at all this year, even if it wanted to in order to alleviate some of the pain.

For the time-being with respect to banking stocks I still think it is a question of watch this space – there is probably more bad news to come.

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