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Risk Of Systemic Failure Grows As Confidence In Banks Sinks To New Low

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It's not just me and the FSA who think short selling a thoroughly suspect activity. No less a figure than Jamie Dimon, chief executive of JP Morgan Chase and a Wall Street legend in his own right, has also been sounding off about it even though his own bank benefited from the trashing of Bear Stearns that short-selling speculators brought about. In the ensuing panic, Mr Dimon was able to buy Wall Street's fifth largest investment bank for a song.

Yet now he thinks that the perpetrators of this bear raid should be hunted down, smoked out and sent to jail. "If someone knowingly starts a rumour or passes on a rumour, they should go to jail", he said this week on US television. Even I wouldn't go that far, yet he is surely right in lamenting the "deliberate and malicious destruction of value and people's lives" which is going on right now in the banking sector.

The trouble with banking as a business model is that it is essentially based on a confidence trick. Banks borrow short and they lend long. The "maturity transformation" thereby achieved plays a key role in the efficient functioning of the economy. Those who have spare cash are united with those who can supposedly put it to good use.

Yet if confidence goes, and everyone wants their money back at the same time, then the system breaks down. The loans couldn't be called in fast enough to repay the depositors. This is precisely the crisis that has been threatening to engulf the banking system for most of the past year.

Banks have struggled to raise the money they need to lend. On a number of occasions, these difficulties have already tipped over into a full-scale run. One such instance was Northern Rock, where wholesale money markets were withdrawing their funding long before small retail depositors started queuing round the block to get their money out.

Something similar happened at Bear Stearns. In both cases, the bearish analysis and rumour- mongering of short-selling hedge funds greatly exacerbated the situation. Money markets and retail depositors look at a plunging share price, and reasonably draw the conclusion something must be wrong.

Confidence evaporates, liquidity pools, which in normal circumstances would be easily sufficient to cope with withdrawals, get overwhelmed and the bank soon gets into a position where it is unable to meet its liabilities. The predictions of disaster become a self-fulfilling prophecy. In economic and financial conditions as fragile as the ones we are currently in, fermenting crisis of the sort just described becomes as easy as pie.

That said, I'm not trying to argue that but for the short sellers everything would be fine on the ranch. Bankers have brought much of the present crisis on themselves. There is a massive, growing and real problem of bad debts out there.

At root, this is what has caused the loss of confidence that is feeding the bear market in bank stocks.Yet what should be a problem that can be contained through recapitalisations, takeovers and nationalisations now shows every sign of ending in wider systemic failure and breakdown.

The latest example of such failure is Bradford & Bingley. The shares fell a further 19 per cent yesterday. The way things are going, they will soon reach the valueless price target one broking analyst has got pencilled in for the stock. Much of the problem is of B&B's own making. In trying to raise new capital, B&B has contrived to commit just about every mistake in the book, thereby creating a sense of crisis around its affairs.

Yet on the face of it, B&B is not an insolvent bank. It is only really the bear market that makes everyone think it might be.

Once B&B gets its new capital, which despite the ever-shrinking share price is not in doubt with the issue fully underwritten, it will be one of the best capitalised banks in Europe. The FSA is also said to be fully satisfied with the bank's funding position. Again on the face of it, there is no liquidity problem of the sort that sunk Northern Rock. Or not yet, at any rate. Wholesale funding is said to be secure.

What could easily change that picture is if retail depositors, collectively accounting for some £21bn of B&B's funding, became spooked, leading to a Northern Rock-style run. The adverse publicity surrounding B&B means there is now a significant risk of this happening. In this regard, the press is proving remarkably responsible. Its reporting of the B&B debacle has on the whole been grown-up and restrained.

The same cannot be said about short-selling speculators, City analysts and the credit rating agencies. As a retail depositor reading some of their missives, you'd immediately run to the nearest branch, and on the safety-first principle get all your money out.

There's more at the link.

Will the B&B really be one of the best capitalised banks in Europe or is this another press confidence trick?

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I bet most of the posters on here could run a bank more sucessfully than the B&B Board. :rolleyes:

Confidence only lasts so long.

Edited by Wait & See

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