KEY POINTS:
"Some of our bankers had shown themselves either incompetent or dishonest in their handling of the people's funds. They had used the money entrusted to them in speculations and unwise loans."
So said Franklin D. Roosevelt in March 1933, in the wake of the American banking collapse that brought on the Great Depression. But his words could just as easily apply today, as we approach the first anniversary of the credit crunch.
Banks are still writing off bad debt linked to sub-prime lending in the United States and elsewhere. As we now know, billions have been invested in financial instruments, packaged in a way designed to keep "toxic" loans hidden from prying eyes. Merrill Lynch last week shocked investors when it revealed it was writing down the value of some collateralised debt obligations by nearly 80 per cent.
But the crisis has shifted into a different gear as the credit squeeze spills over into the real economy and banks are forced to make provisions for mortgages secured against properties whose values are heading south at an alarming rate. Unemployment is creeping up, with tens of thousands losing their jobs in the City of London and on Wall Street.
With forecasters predicting that financial institutions could be forced to write off billions more (on top of the US$200 billion [$275 billion] so far) before the end of 2008, there is creeping unease about prospects for banks both at home and abroad.
For more than 20 years, banks have enjoyed valuations that reflect their strong growth potential, which, roughly translated, means their capacity to lend ever-increasing amounts of cash. But the credit crunch is expected to change that for the foreseeable future.
The banks must rebuild their balance sheets and that means contracting lending, not expanding it. And as regulators draw up plans to prevent a repeat of the credit crunch, banks will have to hold more capital both to restore confidence and to cushion themselves against a possible future drying-up of liquidity.
Bruce Packard, an analyst with Pali International, says: "Perhaps banks will have to go back to being just banks," by which he means becoming more conservative. He adds: "If you go back to the 1960s, average loan-to-deposit ratios at British banks were at around half, which means institutions were lending only 50 per cent more than they held in deposits.
"Compare that with the 170 per cent ratio currently maintained by HBOS." The ratio was even higher at Northern Rock and Bear Stearns, making them particularly vulnerable to the credit squeeze.
In the stock market, bank shares have not been this low for a decade and questions are being asked about whether they will ever get back to the highs of 18 months ago.
Tim Scholefield at Baring Asset Management says: "Stock prices have fallen from over-valued levels; I don't see them returning to where they were at the peak."
According to research by Goldman Sachs, European banks have lost US$900 billion of their market value since the start of the crunch.
"Most people think that there is worse to come and that even now management has not told the full story," says one major City of London shareholder.
"What we desperately need is more transparency."
Citigroup highlights more downside for the sector. A report says: "Our analysts believe that balance-sheet repair will be a drawn-out process. Without a surprising turnaround in the UK and European economy, it's hard to be structurally positive on the fundamental outlook for banks."
Elsewhere, brokers are wondering if, in the medium term, banks will more closely resemble utilities, with steady, low-growth earnings, "making them predictable, but boring", says one analyst.
Graham Secker at Morgan Stanley is not entirely downcast, believing in a possible 15 per cent upside in prices: "A lot of bad news is already factored into the shares. But that doesn't mean we're about to get back to a sustained upward trend."
Ralph Brook-Fox at Resolution says that, for investors willing to give things one or two years, "There is medium-term value in the banks", but adds that he is not heavily invested at this point.
Packard has drawn up a worst-case scenario in which "nationalisation is on the agenda for UK banks". In a report published last week, he draws comparisons with the Nordic banking collapse of the 1980s, which saw many taken into state ownership.
"UK indebtedness is much higher than in the Nordic countries at the time of their crisis," he says.
"According to forecasts, we are less than halfway through the likely US$1.3 trillion of losses, and with debt markets suggesting that UK banks have not raised enough equity, we would be cautious about calling a premature end to the crisis."
As if to underline the point, the Bank of England last week published statistics showing that the number of new home-loan approvals fell last month to the lowest since records began. Approvals for those moving or buying a home fell to 36,000 in June from 41,000 in May, 70 per cent lower than a year ago.
The bank's report came as James Crosby, former chief executive at HBOS, warned it would take around three years before the mortgage market unfroze. He said: "In my opinion ... a shortage of mortgage finance will persist throughout 2008, 2009 and 2010."
Crosby was commissioned by Alistair Darling, the British Chancellor (finance minister) to find ways to ease the logjam, but concluded there were no easy solutions. In his interim report, he said that banks would have to find about £40 billion every year for the next three years just to refinance existing mortgage commitments.
The global picture is no more promising. Citigroup says: "Commercial bank lending intentions continue to contract. As well as reducing the profit opportunities of the banks, this will be a drag on overall economic growth. The default cycle has only just started. That's the bad news - and there's plenty of it."
ANNUS HORRIBILIS
9 August 2007: European Central Bank injects US$130 billion of liquidity into the European banking system as credit markets seize up.
14 September: Northern Rock confirms that it has been granted emergency cash support from the Bank of England.
15 September: Queues start to form outside branches of Northern Rock.
17 September: Chancellor Alistair Darling agrees to guarantee all deposits held by Northern Rock.
16 November: Northern Rock's chief executive, Adam Applegarth, resigns.
17 February 2008: Northern Rock nationalised after failure to agree sale terms with Richard Branson.
7 March: Bear Stearns rescued by the US Federal Reserve and JP Morgan.
22 April: RBS launches £12 billion rescue rights issue, the biggest in corporate history.
13 May: Cash-strapped Bradford & Bingley announces £300 million rights issue.
14 July: Spanish bank Santander announces takeover of Alliance & Leicester.
27 July: Congress approves bail-out plan for giant US mortgage lenders Freddie Mac and Fannie Mae.
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