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How our mutual friends lost their way
September 29, 2008
My first job as a financial journalist was covering British building societies, so the nationalisation of Bradford & Bingley £42bn mortgage book, with Banco Santander favourite to take on its £22bn of retail deposits and its 200-branch network is a striking event.
I used to write about building societies under the guidance of Robert Peston, who was then (in the early 1990s) banking editor of the FT and is now business editor of the BBC. So his assessment interests me:
The nationalisation will be seen as proof that the demutualisation of building societies - which began when Abbey National became a bank in 1989 - has been a colossal failure for both the former building societies and the British economy.
These specialist mortgage lenders were under such pressure to grow their profits, as public companies, that they became reckless adventurers in wholesale funding markets.
I think that is correct. Many of the building societies struck me at the time as being self-satisfied and complacent, largely because they had an very well-tested and safe way to make money. They simply maintained a spread between what they paid on retail deposits and what they charged for mortgages.
The business, in fact, approximated to the old saying about the banker: that he paid interest at three per cent, gave out loans at five per cent and was on the golf course by four o’clock.
As long as most people had variable rate mortgages and they could vary interest rates on savings, this was a risk-free business. Even when fixed-rate mortgages became popular after the 1989-1992 housing downturn, they could hedge the fixed-floating mismatch with derivatives.
Robert mentions that Nationwide, which resisted the rush by other large building societies to demutualise and seek a stock market flotation in the 1990s, has come through the credit crisis in far better shape than rivals such as Halifax, Northern Rock and B&B.
That prompted me to take a look at Nationwide’s balance sheet, which does indeed look as safe as (if you forgive the expression under current circumstances) houses. Most of Nationwide’s funding comes from retail deposits, leaving a modest gap to be funded on wholesale markets.
In the year to April 4, it had £179bn in assets and savings balances of £142.8bn, giving it a wholesale funding ratio of 31 per cent. Northern Rock’s over-reliance on wholesale funding, you will recall, was the reason why it became the first large institution to be bailed out just over a year ago.
But life as public companies encouraged the former building societies to expand their mortgage books, making up the gap between their assets and their savings balances with more wholesale funding.
Complacent and self-satisfied they may have been in their former lives, but they were also solvent.
In order to prevent bank runs and to facilitate the orderly takeover of failing banks perhaps the Govt should legislate for the following:
1) One banking licence per brand (no more multiple brands under one licence).
2) Each brand separately capitalised (so no overlapping assets/liabilities when a holding company controls more than one brand).
3) All cheque books, statements etc to carry a prominent warning of the maximum sum covered by deposit insurance - with regular letters to people holding more to remind them to diversify.
4) A clear distinction between deposit insurance covered accounts (which would have to be in single names and have a cap equal to the deposit insurance) and non-protected accounts (with prominent warnings to that effect).
5) In exchange for granting each banking licence the government would receive a super-senior pref-share that would give it nothing while the bank was solvent but absolute first call on the banks/brands assets if the bank failed. This would mean that nationalisation could effectively wait until a bank filed for bankruptcy. The government/BoE could then step in as the privileged owner of first-resort, seize control of all deposit insurance accounts (non-insured accounts would be frozen), and sell assets to cover the insured deposits first then a percentage of the non-insured second. If that wiped out share and bond holders together so be it).
6) They could also legislate to encourage the launch of super-safe “slim” banks - that would only take deposits (up to a higher insured limits than standard banks) and only lend on the overnight to three month money markets. They would have no overdraft facilities, minimum balance requirements of £250 and would not engage in any other business.
Posted by: Huw Sayer | September 29th, 2008 at 10:46 am | Report this comment“A clear distinction between deposit insurance covered accounts (which would have to be in single names”: so old folks in decline who have joint accounts with spouses or children wouldn’t be covered? For what reason?
Posted by: dearieme | September 29th, 2008 at 11:08 am | Report this commentIt is impossible to lend to “the overnight to three-month money markets”, just as it is impossible to buy “shares in the stock market”. On the stock market, you can only buy specific shares; on the money markets, you can only lend to specific borrowers. It’s up to you to choose shares in companies that won’t go bust, and it’s up to you to choose borrowers that will pay you back. There is really nothing to stop a “slim bank” from getting into trouble by lending to uncreditworthy lenders, and there will be a strong incentive for them to do so in order to get the best rates.
Posted by: Joe Bruno | September 29th, 2008 at 12:39 pm | Report this commentThank you Dearieme - Single names because currently joint-named accounts get the same cover as single-named accounts (guess the alternative is to double the allowance for joint accounts but that might cause complications).
Thank you Joe Bruno - yes I understand that distinction(lost in the short hand of blogging) - and no system is ever perfect - but by spreading risk across many institutions (and possibly by being restricted to investment grade only) they should avoid the mismatch currently besetting banks of borrowing short and lending long against illiquid assets such as property (illiquid when you need them to be most liquid).
My point is that we need to develop a framework that protects savers at minimum cost to taxpayers - that allows for fast track resolution and prevents a run on the affected bank - and that sees both bond and equity investors sharing equally in the pain of bad management (whereas at the moment I understand that bond investors have senior call on assets ahead of govt and savers - please correct me on this point if wrong).
Posted by: Huw Sayer | September 29th, 2008 at 1:46 pm | Report this commentPS: Joe, I said “on the” money markets not “to the” money markets - small semantic point but hey…
Posted by: Huw Sayer | September 29th, 2008 at 1:51 pm | Report this commentDisappointing ‘complacent and self-satisfied’ article - the bulk of which is fluff or attributed to the BBC business editor.
To say Nationwide is safe with £179bn assets in April is naive. The question is what those assets are worth now?
The ex mutuals were ‘reckless adventurers in wholesale funding markets’ But where was the financial legislation to control them? Was this not the FSA’s (or then Chancellors’s) remit?
Sorry, but I expect penetrating insight and investigation from the FT.
Posted by: lapin rouge | September 29th, 2008 at 2:14 pm | Report this comment“…because currently joint-named accounts get the same cover as single-named accounts”: that’s not my understanding, Huw.
Posted by: dearieme | September 29th, 2008 at 2:51 pm | Report this commentHappy to stand correct Dearieme - but last time I looked joint accounts were covered up to £35k the same as single name accounts - not £70k - the compensation is theoretically by account not the number of holders (though the government seems to be bailing out everyone regardless of amounts). If you have a joint account you may like to check this with your provider (or the regulator) - it might also make sense from a tax planning perspective (but for that you may need financial advice).
Posted by: Huw Sayer | September 29th, 2008 at 9:58 pm | Report this commentLapin Rough like everyone else has no public information on the ‘quality’ of mortgage banks assets except any published delinquency rate by borrowers. Of course he may be privy to a FSA review! The FT journalists seem to use this data for example in B&B case and then to amplify the risk because of the known lending offer of the ‘late bank’ even when there is albeit contra soft data on allegedly typical lenders behavior. All of us should in the present situation should try to avoid toxic comments.
Posted by: Peter Copping | September 30th, 2008 at 7:16 am | Report this commentJust to clarify - the compensation scheme limit of £35,000 applies to each depositor, so for a joint account, it is £70,000. This is confirmed on the Financial Services Compensation Scheme website. www.fscs.org.uk
Posted by: Brian Morris | September 30th, 2008 at 10:08 am | Report this comment