DAY TWO OF MAG (& Sir Sean) v. MANDY

Day Two of the HBOS competition appeal - What happened? Merger Action Group (MAG) are seeking to interrupt/ disrupt/ stop the takeover of HBOS by Lloyds TSB (in which Government as underwriter will own 43% or more depending on how many HBOS shareholders do not take up Lloyd's offer, in which case those shares remaining are bought by HM Government, current offer is £1.13per HBOS share, paid in Lloyd's shares). This is a derisory price in terms of the bank's actual size, market share and actual net asset book value. All may change if MAG wins its case. This result should force Lloyd's to have to rethink the purchase price agreement and may potentially cancel the agreement between the two banks?
The MAG legal team say they are at least getting a serious, substantive hearing (under Scottish Law in London) from the Tribunal judges. The HBOS observers say they remain confident the appeal will be dismissed, because the legal move is "an unhelpful and unnecessary distraction", which cannot be described as a serious and thoughtful take on the matter, some might say, as I do, somewhat on a par with the bank's blinkered submissivesness towards Lloyds. Managers' jobs are at stake, but not so assuredly 'at the stake' as 20,000 employees firmly expected to be 'let go' after Christmas. This Friday, we will learn whether HBOS shareholders back the merger with Lloyds TSB and will vote in effect for the job cuts and for selling HBOS for a fraction of its book value? We can expect institutional shareholders, whose hard choices are taken on behalf of numerous pensioners etc., to vote for the jobs cutting takeover as it makes little difference to them as they have more than 80% of the depreciated shares in both banks. Not so - under the takeover, called a “scheme of arrangement”, the board has to win the backing of people holding 75% of all the banks' shares (with institutions, holding more than that and expected to support the deal) - there is a rule to protect small shareholders giving holders of 100 shares the same voting weight as holders of 10 million shares! The rule says that the deal must be supported by 50% of all shareholders. This remarkably makes the institutions a minority. The decision therefore lies in the hands of small shareholders, two million of them. HBOS has merely been able to repeat parrot-fashion that "the legal action is meritless." “There is only one transaction on the table which provides certainty and benefits for our shareholders, including the 200,000 small shareholders in Scotland.” So they believe there are only one tenth the number of small shareholders left compared to what had been? Will they (2 million or 200,000) be swayed by the earlier campaign of the two knights, Burt and Matthewson, by MAG, the SNP government, the unions, or now by 'the king of Scotland' Sir Sean Connery who also supports MAG? Small shareholders (however many have held on to their shares this long) may oppose entirely the view of the banks's boards and HM Government, even though they would be expected to be most directly selfish in the matter. They are angry that so little or nothing has been done for shareholder value, which should at the very least amount to book value (net assets). They are being offered 0.6 of a Lloyds TSB share for each HBOS share, valuing the bank at under £5bn when mid-year book value was still nudging £19bn! On BBC Scotland's Politics Show, Sir Peter Burt said that Alistair Darling, the Chancellor, had been in an extremely difficult position: “In fairness has been the only solution put forward on the table. I blame the HBOS board myself, rather than the Government. If they had displayed a bit more spine than a jellyfish, they could have done a very much better deal for the shareholders, the customers and the employees.” Talking of fairness, The Times reports an attempted judo-throw. MAG was offered a deal by Lord Mandelson's lawyers that they would not seek to recover legal costs, somewhere north of £50,000 at that time, if MAG dropped the case. Other reports say the offer was in a letter from Lord Mandelson. But, legal precedent set in 1953 means that under Scots law, applicants are not liable for costs under public interest legal challenges. Mandelson's lawyers are arguing however that this is not a public interest case? There are now political calls by SNP and Lib-Dems for the minister to be hauled before MPs to answer for his actions, although as a member of the Lords he cannot appear in the Commons. About 40 lawyers are taking part in the case, 35 of them representing Lord Mandelson,HBOS and Lloyds TSB. £50 grand barely covers time-cost for a teabreak in their costs. This offer morally weakens any attempt by Government to recover costs should they win. MAG was anyway able to finesse the move by announcing Sir Sean's support and his letter that argues against the creation of a “super bank”. Sir Sean sagely observes “I never saw anything that got bigger, get better” and that from someone famous for blockbuster movies! If, however, the appeal is granted by the three judges, it means that the Tribunal is saying Lord Mandelson was wrong to set aside competition concerns raised by the Office of Fair Trading with regard to the potential merger. UK Government would appeal, to be heard by the Court of Session in Edinburgh. Could that be expedited before Friday - maybe? If not, does it mean Friday's HBOS shareholders' vote becomes "meaningless"? Er, not exactly. Shareholders could still vote a majority for yes. Institutional investors might, however, think again, factoring in what potential value might be gained or lost by delays to the takeover timetable, and the prospect of the takeover not proceeding at all? If referral proceed to the Competition Commission, the CC report would probably allow the takeover to proceed on condition that certain businesses are sold and some assets are sold or reduced as a share of the UK market, or as a share of geographical/ regional markets (Scotland and North of England). Lloyds intends to writedown HBOS assets anyway and sell parts of its business empire. What MAG might achieve is simply to get this process working the right way round i.e. Competition Commission report first, before a takeover, and not leaving competition issues to be satisfied wholly or partially or not at all afterwards - leaving this merely to the self-sering discretion of the new Lloyd's Banking Group management. The Government's and two banks' logic was that an uncontested merger to be urgently implemented for the sake of UK financial sector stability needed the UK Government to ignore competition concerns. Mr Forrester had some sympathy for Lord Mandelson. For MAG he argued that, while Lord Mandelson is entitled to take a decision to waive competition law, he had to do so based on sound advice that the public interest in the merger going ahead outweighed competition concerns. He said the Business Secretary relied on a statement from the FSA, which wrongly claimed that, under European law, a government-owned HBOS could not "compete aggressively" with private banks? Forrester said Mandelson was legally bound to take advice from the OFT, but not from the FSA, which is "not competent" to advise on competition issues. In his summing up of the case for MAG, he said "There is an elephant in the corner of the room today – and that is the Government’s policy." He said there was clear evidence from the public statements Gordon Brown and Alistair Darling made in mid-September – that were prepared to ‘rip up’ competition law - and thereby already decided the fate of HBOS. "They [the Government] had decided at the highest level that the merger would go through and that competition rules would be waived." He said "it was MAG’s contention that this had been a ‘unique’ decision and the Government’s promotion of new legislation to accommodate the move had been done entirely with the Lloyds TSB HBOS merger in mind... MAG’s challenge was based on the legality or otherwise of the Minister’s decision – a decision that should be annulled".Mr Forrester urged the judge, tribunal chairman Sir Gerald Barling QC, sitting with Michael Blair QC and Professor Peter Grinyer, to order Lord Mandelson to take into account Office of Fair Trading [OFT] concerns about the anti-competitive impact of the proposed takeover and refer it to the CC for further consideration. Mr Forrester added he made no apology for "taking instruction in the case from six sober and responsible citizens ‘who are troubled, worried and aggrieved’ that the merger would lead to a significant restriction of competition within the banking sector, particularly in Scotland."... "It is not fanciful as has been suggested for this group and their 600 or so supporters to be concerned about the impact of this merger on their personal lives, on their businesses and therefore the lives of their employees. Many of them have debts, loans, mortgages with HBOS. They are not busybodies looking over the fence at something that does not concern them. They are regular users of banking services and they will undoubtedly suffer if competition is severely reduced."
Paul Lasok QC, for Lord Mandelson, who had earlier accused MAG of using ‘spoiling tactics’ and ‘inadequate and spurious grounds’ in a bid to block the merger, claimed that MAG’s argument that there was no need for a merger after the Government had announced its banks recapitalisation measures was ‘a matter of judgement’. Lord Mandelson, he said, had exercised his judgement when he decided to allow the merger to go forward without reference to the Competition Commission.
On the opening day of the appeal on Monday, Mr Forrester had told the tribunal that the takeover was ‘preordained’ by the Chancellor and Prime Minister when in mid-September they revealed publicly that they were prepared to ‘rip up’ the rules to allow the deal through without reference to the CC. Forrester could have added that the Government also took advice on stability from the FSA and some advice (content unknown) from the Bank of England. The FSA is responsible for 'resilience' (my word) and not stability, which is BoE's remit. Paul Lasok, QC, for HM Government, said MAG's arguments could be dismissed by the tribunal for lack of required legal standing to bring a case i.e. a technicality body-swerve. He said, referring to the Enterprise Act 2002 (which builds on the Competition Act 1998) that MAG and the persons (and businesses) it represents do not have sufficient interest in the competition issues, with an additional interpretation (not strictly available in the Act) that these parties needed to have a greater interest in the deal than the public at large. "The complainants have not identified any factor that distinguishes them from customers or the general public," he said. This is a curious but weak gambit since the appeal claims a breach of the law (if Mandelson was not free to take a decision because it was taken for him by The Chancellor Alistair Darling 6 weeks earlier and that Mandelson had not taken full and proper advice before deciding to waive the necessity of referral to the CC!). It is also a weak technical objection given that John Swinney, the Scottish government's finance secretary, has given his Government's tacit support to MAG. Also, First Minister Alex Salmond told MSPs that Mr Swinney had written to Mr Justice Barling, President of the tribunal, expressing the Scottish Government's concerns, albeit that Mr Swinney was careful to state his Government was not becoming a party to the case, but his letter effectively suggests that MAG does have a representatively legitimate basis for its 'Third Party' Appeal. Moreover, the Scottish Government made a formal response to the OFT setting out its concerns (included with Mr Swinney's letter to the Tribunal). One may wonder though why UNITE the Amicus/TGWU trade union has not made itself party to the MAG case since tens of thousands of its members, plus husbands, wives and children and another several thousand retail trade employees etc. are all at risk of severe fall in living standards! Bank of Scotland's motto for years was "A FRIEND FOR LIFE" until it merged with Halifax. But, then unemployment is not a competition law issue, or should it be since the members are also bank customers, or is that just introducing extraneous morality issues that should not be counted as part of the equation between benefits and competition? As a measure of how hard or hard-up HBOS is, the bank has ordered that there are to be absolutely no staff Christmas parties this year, at least none involving any expense by the bank (Scrooge-like fearful of public opprobrium when in receipt of Government subsidy) - rather hard on the thousands about to be cut for whom this is their last opportunity to celebrate with colleagues. If any doubt HBOS's scrooge credential, recall Farepak’s collapse in 2006 when Christmas was ruined for thousands of families. The HBOS bank pulled the plug on the scheme’s parent company – and 120,000 people lost a total of £38 million in savings. Victims were told they could get 5p in the £, but have got any so far? The only other defence of Mandelson's decision is that "...any relevant customer benefits in relation to the creation of the relevant merger situation concerned outweigh the substantial lessening of competition concerned and any adverse effects of the substantial lessening of competition concerned..." Forrester headed this off by claiming that Mandelson did not take sufficient advice from the appropriate bodies on this. Oh yes he did! Oh no he didn't! How to adjudicate that one? The Tribunal has 'economic advisors'. After Mr Lasok concluded his arguments today representatives for HBOS and Lloyds TSB made their submissions to the tribunal. Nicholas Green QC, for HBOS, told the tribunal that Lord Mandelson had ‘discretion in law’ to make the decision he did, having taken into account what was best for the economy as a whole. Helen Davies QC, for Lloyds TSB, claimed there was no proof that Lord Mandelson had been ‘fettered’’ by the statements made by the Prime Minister or the Chancellor. She was implying that MAG's evidence to the contrary is purely circumstantial!
These issues also involve the "SECRET DOSSIER", of which there is now reason to believe there may be two dossiers? Is it the "smoking gun"? To vacate keen interest in this Alistair Darling, the Chancellor, insisted yesterday that preparation of the dossier was a routine legal matter only, prepared from the UK government's side, but confidential and therefore not shared with MAG. This is a remarkable change of story, when we'd learned preiously the dossier was prepared by either or both HBOS and Lloyd's TSB. I suspect there are now two dossiers! The first was made in September or 6 weeks ago and as a file includes (or not) the basis for the £10bn loan from Lloyd's to HBOS. The second (at least the one Darling is referring to), the Government's, was probably made when HBOS got its £11.5bn capital infusion, and this one probably and conveniently (speculative supposition) lacks detail on the Lloyd's loan that could conceivably be deemed to contain anti-competitive 'tying' or even (again speculation only) agreement clauses breaching basic competition law principles? Would it reveal somehow that HBOS can only avoid insolvency by being taken over, or would it reveal an anti-competitive clause attaching to the Lloyds £10bn loan to HBOS, either way lies the possibility of case proven for or against. But, with all my financial & banking experience I cannot imagine how inevitable solvency can be proved. I can, however, precisely imagine how the loan might have breached competition law! The Tribunal's decision is expected tomorrow, Wednesday, two days before HBOS shareholders are due to vote at the bank's general meeting (in Birmingham?). The Government would have succeeded here better by taking a solid view on benefits outweighing competition issues (the latter confirmed by OFT) and then getting the CC to rubber-stamp it quickly, and then be able to claim with some confidence that this was the best course in the wholly exceptional circumstances. But, only if, despite the Government's £11.5bn out of £56bn capitalisation funding and Darling now considering whether to expand a £250bn Treasury programme to support by guarantee interbank funding loans between U.K. banks, and to guarantee cover for much or all of the £1.2tn UK mortgage market (Crosby Review). Some, including those who fear the possibility of outright nationalisation of the banks, may say it is impossible to know yet if those exceptional circumstances endangering HBOS's solvency have changed at all for the better (a conclusion that might serve the case but be totally damning to the Government's policy?!). But, of course, stability in solvency risk terms is certainly (at a basic level) now assured; neither bank is at risk of insolvency failure. The unplain, highly varinished fact of the matter is that there is no one direction in which to determine clearly what makes most (or the only) financial good sense between the takeover and allowing HBOS to keep its independence. My view, for what that is worth, is that HBOS can survive as an independent bank with temporary Government support and dose not need to be taken over by any other bank, or any other rich investors! If, following tribunal proceedings, competition concerns are paramount, then the initial logic behind the speedy-motors merger fades like a Cheshire smile. The BBC's Brian Taylor, one of Scotland's media treasures, on his BBC blog wants to draw the attention of the judges to the case of MacCormick & A.N.Other v The Lord Advocate (1953 SC 396) who contested the right of the Queen to bill herself as Elizabeth II in Scotland. Well in the MAG case the Queen's representatives have tried threatening to bill MAG for costs (intimations?) "Ian Hamilton QC, who was involved in the case, has contacted the Merger Action Group, arguing that there should be no question of facing costs should their case fail. He says that, after the MacCormick case failed, costs were moved for - but were refused...the court is reluctant to award costs in Scotland where people act in the public interest, even if unsuccessfully". This is probably exactly right and is the view of the MAG team. If MAG loses it may try appealing to Brussels or to both Houses of Parliament or simply to the Law Lords, but these may prove unlikely to delay the takeover. I suspect that some compromise decision may be sculpted that satisfies neither side fully. I say this without any clear idea what that could be? Brian notes for us that he has just finished reading QC Hamilton's book on the Stone of Destiny I have recently finished re-reading. This recalls me to Walter Scott's letters in 1926 under the soubriquet of Malachy Malagrowther that most artfully at great length successfully defended the right of Scottish banks to issue their own banknotes against a London Government proposal to make only Bank of England banknotes legitimate or lawful tender. My own inside information on that case was that behind the scenes Scott blackmailed HM Government by threatening to reveal the hiding place of the true Stone of Scone (also called Stone of Destiny and believed to be shiny black basalt Jacob's Pillow from Sinai, not a piece of sandstone) that would have put into question the legality of British Kings and Queens to the Scottish throne, which by time immemorial (since at least The Bruce) requires crowning on the true stone, which brings us back to the MacCormick case, and that of HBOS too!Given that the merger of the two banks is actually a Government measure (subject to Parliamentary oversight too) then it potentially comes under the Treaty of the Union (1707 full political union, merger of Parliaments & abolition of the Scottish one), precisely the ground upon which Walter Scott won his case (conducted in Edinburgh Review newsprint, read in London, and debated in Parliament). As Scott put it, "...virtue of a solemn Treaty of Union. Nay, so distinct an idea had he (referring to his ancestor of the time of the Union) of this supposed Treaty, that he used to recite one of its articles to this effect: -- "That the laws in use within the kingdom of Scotland, do, after the Union, remain in the same force as before, but alterable by the Parliament of Great Britain, with this difference between the laws concerning public right, policy, and civil government, and those which concern private right, that the former may be made the same through the whole United Kingdom; but that no alteration be made on laws which concern private right, excepting for the evident utility of the subjects within Scotland." When the old gentleman came to the passage, which you will mark in italics, he always clenched his fist, and exclaimed, " Nemo me impune lacesset! " This is why Scott (who was, like Sir Sean and any big Scottish sports star, familiarly called "The King of Scotland" - in Scott's case from when he hosted the visit of George IV), why Scott's likeness continues to grace Bank of Scotland notes (not, by the way, ever called HBOS notes). His case was that the UK Government has a constitutional treaty obligation (as much as any UK constitutional nicety can be an obligation in the UK even if it is a formal treaty) to demonstrate to the satisfation of the people of Scotland that any measure affecting a private Scottish interest, or an exclusively Scottish measure applied by the UK Parliament, is demonstratively and agreeably in the Scottish people's interest. This obligation was not appealed to at the time when the Poll Tax was applied uniquely to Scotland, but that does not mean it is not still operating and can be appealed to?
Scott's use in his first letter of Nemo me impune lacesset! had its desired effect too - on English nervous lawmakers. This is the Latin motto of the Order of the Thistle, of three Scottish regiments and the Royal coat of arms of the Kingdom of Scotland and in the version of the Royal coat of arms of the UK when used in Scotland. It is often translated as No-one provokes me with impunity, or rendered in Scots as Wha daur meddle wi' me? ("Cha togar m' fhearg gun dìoladh" in Scottish Gaelic), which rendering may explain why in the USA it is also the motto of the guns lobby, the right-to-bear-arms enthusiasts. It may also mean let any who trend on me should fear injury or will be injured or killed, hence the American versions have a rattlesnake logo. What made it doubly impressing in 1826 was that this was the motto on some of Revolutionary America's flags and banknotes (e.g. Georgia), and that association may have concentrated minds further, as indeed should be so in this case regarding the possible impact on how Scotland will respond to Labour next time round at UK and Scottish elections! I'm fascinated to know what is in the 'secret dossier' or dossiers? I wonder if our investigative journalists will have any more luck than they did with that other secret dossier that eventually led to PM Tony Blair's loss of almost all popular trust?

MERGER ACTION GROUP – NEWS RELEASE

MONDAY, DECEMBER 8, 2008 FILED AT 2.30PM
Neither the Prime Minister, the Chancellor nor the Business and Enterprise Secretary had the power to waive competition law when they allowed the proposed merger of Lloyds TSB and HBOS to proceed, a court heard today (Monday). Ian Forrester QC, representing The Merger Action Group [MAG] told the first day of a hearing into the legality of the Government’s move, that only parliament could have altered the legal criteria that would have permitted the deal to go ahead without reference to the Competition Commission. He said Business Secretary Lord Mandelson, who approved the controversial move on October 31 this year, ‘made an error in relation to competition law’ and that neither he, Gordon Brown nor Alistair Darling had the authority to waive the rules as set down in legislation.
A panel of three judges at the Competition Appeal Tribunal, presided over by Sir Gerald Barling QC, are hearing the appeal brought by MAG against the Government’s decision. The group, an association of businessmen, shareholders, customers and bank employees, claims Lord Mandelson acted unlawfully. Mr Forrester told the hearing that MAG had won the backing of some 630 members of the public, while First Minister Alex Salmond and Mr Peter Vicary-Smith, chief executive of Which? – Europe’s largest independent consumer body with more than 700,000 members - were among others who had written to the court in support of the appeal. Although the hearing is being heard in London, it is being conducted under Scots law because the applicants are mainly Scotland-based and the impact of the merger if it goes ahead will be felt more keenly north of the Border than elsewhere. Opening his case, Mr Forrester said MAG was ‘a group of responsible individuals pursuing a real and legitimate interest.’ He said they shared the concerns of the Office of Fair Trading [OFT] which, in a report before Lord Mandelson’s made his decision, warned that the merger could lead to a significant lessening of competition. The OFT said the takeover should be referred to the Competition Commission for further investigation. However, Lord Mandelson disregarded this advice after both Mr Brown and Mr Darling had earlier spoken publicly in favour of the merger. Mr Forrester said the proposed merger should have been open to public scrutiny, but that ‘the Government had a clear policy’ that the deal should go ahead. He added: ‘The decisions and statements by the Chancellor and the Prime Minister and the clear policy that they adopted were meant to bind, and did bind, all Government departments. ‘Any Minister, even one of great distinction who has served in several governments and the European Parliament (Lord Mandelson), could not have failed to have been influenced.
‘But what the Secretary of State should have done was to balance public interest concerns against competition concerns as expressed by the OFT.’ Instead, Mr Forrester said Lord Mandelson ‘denigrated the concerns of the OFT’ which he described as a ‘manifestation of the fettering’ of his decision. Mr Forrester said the Chancellor’s public statement in September following the collapse of the HBOS share price that the Government had made the decision to waive competition rules to allow the deal with Lloyds to go ahead was a ‘deliberate and pre-meditated statement of policy’. Yet, he said, Lord Mandelson’s decision to follow this course of action was clearly unlawful since he had rejected the OFT’s report and failed to justify the anticompetitive nature of the merger. He added: ‘Lord Mandelson failed to follow the rules and proper steps he ought to have taken when dealing with this type of merger where there are public interest concerns and considerations.’ Mr Forrester said Lord Mandelson had claimed that unless the merger went ahead, the future of HBOS would be in serious doubt even though, by then, the Government had announced a major rescue package for the banking industry. ‘It was a rather less bleak prognosis from the OFT who believed that HBOS could still be a competitive force, albeit a weaker force than it was prior to the
economic crisis,’ he said. Mr Forrester said in the longer-term, the OFT believed HBOS would be a ‘considerable player’ in the market place once it had paid back the money it would receive from the Government aid package to help it recapitalise. He said Lord Mandelson did not give enough weight to alternative solutions. He called on the tribunal to quash the Minister’s decision and refer the proposed merger to the Competition Commission.
Paul Lasok QC, for Lord Mandelson, asked the court to consider whether the Minister had behaved like a puppet or whether he had made up his own mind about waiving competition rules to let the merger proceed. He contended that Lord Mandelson did have a open mind and properly balances competition considerations against public interest concerns before making his decision.
BERR, iwith support from HBOS and Lloyds, will continue their defence tomorrow [tues] when the hearing resumes. It is expected to conclude tomorrow afternoon [tues] and Mr Justice Barling QC has indicated that the panel will endeavour to reach a quick ruling. Shareholders in HBOS are due to meet in Birmingham on Friday to vote on the proposed merger. Background to the appeal:
The circumstances which led to MAG’s formation and appeal began on September 16 when the HBOS share price fell to 88p, casting serious doubts on the bank’s ability to raise funds on the money markets. The following day, it emerged that HBOS was in advanced merger talks with Lloyds TSB. The Prime Minister Gordon Brown revealed that he had personally intervened to broker the deal and made clear the Government was prepared to ‘rip up Britain’s competition laws’ to allow the merger to go ahead. The Chancellor, Alistair Darling, added: ‘We have made a decision that we will waive the competition requirements in relation to these two banks – that’s not going to be revisited.’ On September 18, the then BERR Secretary John Hutton, announced that the Government would introduce an Intervention Order that would set aside the Office of Fair Trading’s stated concerns that the proposed merger would lead to a significant lessening of competition. Such concerns by the OFT would automatically, under competition legislation, lead to the matter being referred to the Competition Commission for further investigation. But this step was bypassed after the Government intervened.
By the beginning of October, it was recognised by both the UK and US governments that a rescue package was required to support the stability of the financial systems. The UK Government announced a package of £400 billion and on October 13 announced a total of £37 billion to be invested in three banks,RBS, Lloyds and HBOS. The Government stated that the recapitalisation was designed to help those banks receiving funds to achieve prudent but efficient capital structures. On October 31, Lord Mandelson – who had succeeded Mr Hutton – confirmed that he was overruling the OFT, claiming competition issues were outweighed by the public interest benefits of creating financial stability.
MAG’s case against the Secretary of State is based on three key points:
● In law, the Minister was obliged to keep an open mind when making his decision. However, statements made by the Prime Minister and Chancellor of the Exchequer in September ‘fettered’ the Minister, thus preventing him keeping an open mind when making his decision on October 31.
● Instead of using the legislation in place at the time of the merger as the justification for not referring the merger, the Secretary of State promoted new laws specifically to approve the merger, thereby retrospectively giving powers to himself that were not available at the time the merger was announced.
● The decision was predicated on the justification that if this specific merger did not take place HBOS would collapse and destroy stability in the financial system.
Following the Government rescue package this was no longer the case, because there was provision for the Government to provide the capital as stated by the OFT, and therefore his decision was made on a false assumption. MAG maintains that the ‘unlawful’ actions over the proposed merger of Lord Mandelson were against the interests of fair competition, HBOS, its shareholders, its customers and its workforce, and that they will stifle competition.
For further information please contact:
Ian McKerron on 07740 510411 or
Gordon Hay on 07784 772905

SECRET DOSSIER

In a comment to recent blog, I refer to a trigger used to leverage government support for Lloyds TSB's (LTSB) takeover of HBOS. Echoes of another 'dossier' now become a blighted word in any context '- a secret dossier', now in hands of lawyers for the Government and the tribunal judges only!
The story of the takeover has changed. First we were told that Victor Blank buttonholed Gordon Brown having seen the opportunity to takeover HBOS and got GB's support. Now, the story is that HBOS approached LTSB to say they were in deep urgent trouble! This could in my view only have been a Northern Rock problem fear following the collapse of Lehman Brothers and the fear that wholesale funding for the banks will dry up absolutely! - that problem of being unable to book refunding from other banks for the quarters ahead (HBOS as we know has to roll-over £132+bn in the next year and probably £50bn this quarter). If so, some banks, including major UK banks, may now regret not having been more active in making use of the Bank of England SLS window before 15 September. So LTSB was approached and loaned HBOS £10bn, the secret Victor Blank cheque engagement ring for what has become a shotgun wedding. In the 'secret dossier' there would have been an analysis of the liquidity problem (by HBOS, or by HBOS & LTSB, or by LTSB alone?) and this would be from several sources including bank of England, FSA, HM Treasury and the banks themselves, including possibly accounts information shareholders are not yet informed of about funding or systemic stability issues, or may never be informed about? At the 3rd December tribunal hearing of the Competition Appeal Tribunal (CAT) the presiding judges decided that only the lawyers are allowed to see this, not the MAG principals. And in the court case (which was accepted as a valid appeal to be heard on Monday 8 Dec)only high-level summaries would be permitted. The 'secret dossier' is deemed to be highly confidential. It may conceivably include the terms of the £10bn loan, and these may contain conditions pertaining to the HBOS board agreeing to the LTSB takeover etc.? This is speculation. But, such conditions, if they exist, may be subject to interpretation as anti-competitive practise of 'tying'! Undoubtedly, market conditions were extraordinary and it can be argued that demanded extraordinary responses? At the time (17 Sept.) after "emergency discussions" personally overseen by Gordon Brown a merger deal was agreed between LTSB and HBOS. It came after HBOS shares plummeted for a third day, at one stage in one day dropping 70% under short-selling pressure. The Government's bailout was not yet on offer (not until mid-October). The HBOS Board probably felt it was exactly in the Northern Rock category of liquidity risk and that an appeal for emergency help from BoE and/or HMT might again trigger a similar bank-run! But, history does not repeat itself a year apart, yet the Board may have feared precisely that? As any who look will know, HBOS accounts are not showing poor performance or excessive impairments compared to others, even though writedowns for 2008 (at 3Q interims) doubled from about £2.5bn to just over £5bn between 30 June and 31 October. Nonetheless, perhaps judging by share price performance in the belief that the markets know best, HBOS has been dubbed an especially troubled bank. Commentators have said this is a 'shotgun marriage'. If so, the shotgun may be the £10bn loan and the cartridges in it are the conditions attaching to the loan. The nature of these would be designed to ensure that HBOS does not entertain other potential suitors and explains why the HBOS Board has been so adament that there is no other choice and the brusqueness with which it rubbished the letter from the 'two knights'. This is merely speculation, not established fact. The existence of the 'secret dossier' is fact. That this dossier was shown to the Government (and if them, why not also to major institutional shareholders?) would go some way to explain its attitude that this merger is a done deal that has to be pushed through including by-passing the Competition Commission (and in advance of the shareholder vote) and believed to be unavoidably necessary to financial stability in terms of HBOS's solvency (in short term cash-flow terms i.e. liquidity risk). Any alternative buyer would have to immediately replace the LTSB loan, possibly merely as a condition to see the books and to discuss with the HBOS Board, as well as find the full net asset purchase price, and to do so without reference required to the CC. Therefore, such a buyer would have to be foreign or a much smaller UK bank than LTSB? Any other alternative would have to be Government, or another bank or syndicate of banks, prepared to lend £10bn on market terms without special conditions except possibly stock warrants (or prefernce shares) when the total stock market value of the bank is only 60% of the value of the loan. Government subsequently committed (at a current m2m loss for £11.5bn to HBOS including £2-3bn preference shares). This all hung like a Damocles sword over what HBOS could do now to efficiently refinance or roll-over its wholesale market funding once it had Government backing and should thereby be able to negotiate funding with more market confidence, unless the LTSB loan conditions (assuming these exist) cut off that option? What is clear, however, is that HBOS liquidity risk creditworthiness in the market gained by Government support, on the one hand, was taken away by Chancellor Darling's statement, on the other hand, just before the LTSB shareholders voted on 18th November saying that if the LTSB takeover of HBOS was voted down by shareholders then the Government's coninued support could not be relied upon automatically; it would have to be re-applied for (in a context of the Government's conditions being verbal and not written). The BBC's Robert Peston noted that the chancellor (MP for South Edinburgh) "raised strong doubts about whether the Treasury would provide vital new capital to an independent HBOS and he has also made it clear that the cost to HBOS of such capital (were it to be provided) would be almost prohibitively expensive", which is ironically the problem that HBOS faced at the outset leading to its loss of independence. Peston continued, "most HBOS shareholders would take the view that voting to block the takeover against the revealed wishes of the Treasury would be an instance of turkeys clamouring for an early Xmas. There is evidence that many (perhaps most) investment institutions support the deal. That can be deduced from the overwhelming support for the takeover shown today in a vote of Lloyds TSB's shareholders. The reason it's possible to extrapolate from that vote is that there is an overlap of more than 50% between the institutions owning HBOS and Lloyds TSB". He finished with, "So I think it is reasonable to predict that this takeover will now take place. And it's also reasonable to predict that as and when Lloyds TSB reduces the headcount of the combined banks by 20,000 or more - as it must do because of the overlap between the operations of these two large organisations - some members of the government will not feel totally euphoric in getting what they wished for". The regret may be felt not only by some MPs but also by the Labour Party in Scotland, who while on the one hand have categorised all this as evidence for why an independent Scotland would (like tiny Iceland) prove to be unviable in a crisis, may find that the cost includes longer term exclusion from majority power at Holyrood than the party might otherwise have expected.
Burt and Matthewson, the 'two knights', who until this point had led a last minute campaign against the deal, now recognised that their appeal for HBOS to show more negotiating flexibility on behalf of shareholders and to seek alternative routes to maintaining independence was now futile.Thus, it follows, that despite the Government's primary concern to restore UK financial stability, HBOS (one of the UK's domestic big 3 and big 5 banks) it is prepared to risk this objective by its determination to corral HBOS into the LTSB takeover/merger. Whether or not there is any political game-playing affoot, the moral hazard risk here is that both banks, should they or their shareholders (some, or many, of whom are common to both banks) have thought to back off from the deal they too must now feel they have no other choice but go ahead anyway. Hence, no other banks (UK or foreign) can intervene or offer alternatives, no matter how angry they are about the projected new Lloyds Banking Group gaining a super-dominant position of 30-40% of the domestic banking market and 38 million account holders (that the OFT believes is an anti-competitive market share in important asset classes and regions). Other banks could spoil the party by offering £10bn+ loans to HBOS, but why do that? The other domestic big banks will seek to refer the new super-bank to the Competition Commission after the takeover and press the bank to sell-off business units and assets to them above some market share threshold to be determined by the Competition Commission. LTSB has said it intends to writedown HBOS's assets (book value) and to seek buyers for some of HBOS's business holdings. In the meantime, after CAT, if CAT does not grant the appeal by MAG, the EC's Competition Law may also be appealed to. At the EU level there is concern about the integrity of the Single Market, about area, region and cross-border market shares and any potential for, or actual, anti-competitive practises. What is equally concerning to EU authorities is how liquidity risk can lead to bypassing or overriding of Competition Law process, even if an ex ante referral becomes instead an ex post referral. This is a concern too at EU level concerning fiscal and financial responses in respect of what common framework to apply to each state's bank capitalisation support measures. At the heart of this are two factors, systemic risk (national financial sector stability) and liquidity risk (credit crunch in interbank loans and deposits). The UK, for example, has just announced it will require banks to buy new Government bond issues to an amount equating to about 10% of assets (to total loans i.e. more than the total of their 'own capital' and more than the total of their economic capital reserves) including foreign government bonds but only in proportion to the international mix of their assets. One common feature agreed as part of the common framework is that capitalisation support for banks should be as temporary as possible. In the UK the Government's share will be replaced in 2009 by Government bond holdings. Will this resolve any still peristing liquidity risk problems?
Therefore, from the above, the CAT case by MAG may hinge on whether the Government is condoning anti-competitive practises and moral hazards:
- by giving in to possible anti-competitive conditions attaching to interbank loans during the credit crunch e.g. any special conditions attaching to the LTSB £10bn loan to HBOS that would severely restrict HBOS's freedom to search for better alternaties for its shareholders, customers and employees etc.
- by bypassing ex-ante reference to the CC and Government taking on the legal role of the CC onto itself merely on the basis of a 'secret dossier' etc.
- by failing to examine alternatives fully (if the HBOS board is constrained from doing so itself?) including full analysis of HBOS's liquidity risks and systemic importance by the Bank of England, which is the authority responsible for financial sector stability, not just the opinion of the FSA, which is responsible for individual bank's financial resilience, and possibly for not obtaining the views of the other major UK banks, and for not referring this to the CC, especially after the OFT's negative report, and
- by failing to balance long term effects with short term expediency measures and challenge its own assumption about net benefit in the public interest. The MAG case only secondarily touches on the above. Its principal case is that the Secretary of State after obtaining a discretionary power to bypass the CC via an order in Parliament and only after the merger was agreed between the banks then illegally applied this new power retrospectively. In pitching its case, however, the MAG legal team may seek to uncover whether 'anti-competitive' conditions were attached to the £10bn loan by LTSB to HBOS as well as whether the 'secret dossier' or any other advisory reports obtained by Government were technically sufficient to influence its actions including the obvious arm-twisting by the Chancellor just before the LTSB shareholder general meeting and vote.

LEGAL CHALLENGE TO HBOS MERGER DECISION

A group of businessmen, customers, account holders and shareholders is mounting a legal challenge against the UK Government’s controversial move to allow the merger of HBOS and Lloyds TSB without referring it to the Competition Commission. The Merger Action Group [MAG] has lodged an application with the Competition Appeal Tribunal [CAT] claiming the decision by Business, Enterprise and Regulatory Reform Secretary Lord Mandelson was ‘unlawful’. The group, whose spokesman is Edinburgh architect Malcolm Fraser, responsible for the repair and renewal of HBOS HQ on The Mound, has submitted a 37-page appeal with CAT, which has the power to overturn the Government’s decision. The group is asking for the tribunal to sit in Edinburgh because the appellant is Scottish and both Lloyds TSB and HBOS are registered Scottish companies. However, the group wants to act as a rallying point for interested parties across the UK. They will be engaging with trade unions, industry bodies, consumer associations and communities across the country in an attempt to ensure the public interest is protected. Mr Fraser said: ‘As a group, we are extremely concerned that due legal process has been ignored. In Scotland particularly, there is a widespread and growing unease about what has taken place. ‘Given that taxpayers are ultimately funding the takeover, we are simply asking that the law is properly applied, and that our long-term interests are protected. We do not feel that is too much to ask.’
CAT, comprised of High Court Chancery Division judges and other senior lawyers, is presided over by Sir Gerald Barling QC, one of the UK’s most experienced competition and technology barristers. MAG has engaged Brussels-based Scots advocate Ian Forrester QC, a specialist in European and competition law, to lead the appeal. Given the legal implications, MAG initially restricted itself to contacting some of those who have previously spoken out about the merger, but has been setup to accommodate all those who wish to join. MAG expects a huge interest over the next few weeks. Mr Fraser went on: 'Let no-one doubt the seriousness and responsible nature of our submission. We have taken the best legal advice on UK and European competition law, and feel that we have uncovered matters which deserve proper consideration.' ‘CAT has available a number of remedies, all of which we feel would be better than a decision which we feel was taken in haste, and without cognisance of
changing circumstance. This is an official review before High Court judges. They have the power, under the Act, to force the Secretary of State to refer the proposed merger to the Competitions Commission and their decision is legally binding. Decisions by the Secretary of State to refer a merger to the CC have been challenged through CAT in the past. However, this is the first time a decision not to follow a decision made by the OFT to refer the merger to the CC has been legally challenged. We are not taking this step lightly but feel it is in the interests of jobs, competition and the taxpayer that the decision must be seen to have been taken properly. The implications are so huge that we could not comfortably stand aside.’ In conjunction with the official Appeal, MAG is launching a public ‘grassroots’ campaign for support from anyone – business people, mortgage holders, current account holders, shareholders – who shares its view that the proposed merger should have been referred to the Competition Commission. The circumstances which led to MAG’s formation and appeal began on September 16 when the HBOS share price fell to 88p, casting serious doubts on the bank’s ability to raise funds on the money markets. The following day, it emerged that HBOS was in advanced merger talks with Lloyds TSB.
The Prime Minister Gordon Brown revealed that he had personally intervened to broker the deal and made clear the Government was prepared to ‘rip up Britain’s competition laws’ to allow the merger to go ahead. The Chancellor, Alistair Darling, added: ‘We have made a decision that we will waive the competition requirements in relation to these two banks – that’s not going to be revisited.’ On September 18, the then BERR Secretary John Hutton, announced the Government would introduce an intervention order to overrule a decision by the Office of Fair Trading [OFT] to refer the proposed merger to the Competition Commission. By the beginning of October, it was recognised by both the UK and US governments that a rescue package was required to support the stability of the financial systems. The UK Government announced a package of £400 billion and on October 13 announced a total of £37 billion to be invested in three banks, RBS, Lloyds and HBOS. The Government stated that the recapitalisation was designed to help those banks receiving funds to achieve prudent but efficient capital structures. On October 31, Lord Mandelson – who had succeeded Mr Hutton – confirmed that he was overruling the OFT, claiming competition issues were outweighed by the public interest benefits of creating financial stability. MAG’s case against the Secretary of State is based on three key points:
● In law, the Minister was obliged to keep an open mind when making his decision. However, statements made by the Prime Minister and Chancellor of the Exchequer in September ‘fettered’ the Minister to keep an open mind in making his decision on October 31.
● Instead of using the legislation in place at the time of the merger as the justification for not referring the merger, the Secretary of State created new laws specifically to approve the merger, thereby retrospectively giving powers to himself that were not available at the time the merger was announced.
● The decision was predicated on the justification that if this specific merger did not take place HBOS would collapse and destroy stability in the financial system. Following the Government rescue package this was no longer the case, because there was provision for the Government to provide the capital as stated by the OFT, and therefore his decision was made on a false assumption.
MAG maintains that the ‘unlawful’ actions over the proposed merger of the Prime Minister, Chancellor and the Secretary of State are against the interests of fair competition, HBOS, its shareholders, its customers and its workforce, and that they are stifling competition. Mr Fraser said: ‘The Government has gone out of its way to discourage alternative interests to come into play for the future of HBOS. This is not a level playing field. We aim to level it, and to ensure that the UK's public interest is served as it should be.‘Our primary concern – as recognised by the OFT report – is that the Government has ripped up the competition laws. These concerns will come back to haunt us in the future.
‘Lord Mandelson, in our view, is acting unlawfully.’ The Merger Action Group's Merger Appeal CASE will start on Monday and should be completed by Tuesday. In less than a week, over 500 people have signed up to support the campaign; a mixture of small shareholders, employees, and business people. MAG is asking for everyone to tell as many friends and colleagues as possible about the campaign, especially in Yorkshire or Edinburgh and other areas affected by potential job losses to make more people aware of campaign by asking them to click here: www.mergeractiongroup.org.uk
In a week, MAG lodged its appeal, signed up hundreds of people, had the case accepted (Wed 3 Dec) and fast-tracked for Monday (8 Dec) and also won an historic decision that it should be held under Scots Law.
see also http://creditcrunchimagery.blogspot.com
and http://www.union-legend.com/uploads/publwp/UL-Lloyds_TSB_acquisition_of_HBOS.pdf

FINANCIAL TRANSPARENCY?

US Treasury Secretary, Hank Paulson, told Congress ““We need oversight. We need protection. We need transparency. I want it. We all want it.'' - regarding the use of TARP funds. In my opinion there was transparency in Treasury announcements to anyone who looked hard enough, and yet Bloomberg filed a lawsuit to gain access to information to determine where taxpayers’ money was being applied and especially what securities were being pledged in swaps for Treasuries. The Government quite rightly witheld the names of banks applying at the Fed's window simply to protect them from being undermined unreasonably in the stock market e.g. by short-sellers. Nonetheless, what this does nothing to relieve is the panic that investors and others feel about murky toxic-smelling hidden depth of banks' footnotes to accounts regarding Off-Balance-Sheet Items (OBSIs). Investors expect to be able to do due diligence about risks and returns and current banks' share values tell us that when these fall far below book value that investors and traders are discounting heavily the quarterly and annual accounts, which they simply refuse to believe are true and fair! How important is confidence in public sector finance as much as publicly quoted private finance? Are there moral hazards involved here too? Take Citigroup for example. As it was bailed out by the government, it transferred assets from Structured Investment Vehicles back on balance sheet and into assets held for sale but price-adjusted as if to be held until maturity, after a $1.1bn negative value adjustment that would hit future p&l. But, then Government guaranteeing a fifth of Citi's assets, greatly supplemented its capital reserve ratio and proided guarantees whereby it could sell 20% of its assets (currently $1.55tn in total) at a reasonable price. What is even more opaque, however, are banks' exposure to credit and liquidity guarantees for off-balance-sheet loans and bonds in SIV/SPEs. The US top 7 banks and foreign banks such as Lloyds TSB, RBS and HSBC have together more than $300bn in such exposures. The guarantees were to solvency-remote entities when first pledged as risk insurance inducement to buyers of senior and mezzanine tranches of securitization RMBS, CNBS and other ABS bonds etc. Now, as RMBS and CMBS defaults are edging above 10%, plus credit-card delinquencies going higher, some of these standby CPs will be called on. Yet these items are not disclosed or only barely, in notes to banks' Financial Statements and insufficiently to allow readers to make informed decisions. Possibly, auditors are not informed fully clearly either? Some of these exposures are merely bundled into larger portfolios of structured finance stress test model results. The Financial Accounting Standards Board (FASB) and its proposed amendment to FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, addresses this. This proposed amendment would change what and when OBSIs would have to be consolidated into a company’s books and reported publicly, as well as eliminate the ability to create certain types of OBSIs. This should immediately impact the financial positions of many companies by bringing to light obligations previously hidden. The amendment was meant to apply to fiscal years starting after November 15, 2008. But, implementation is opposed by Citigroup Inc. and the securities industry generally and is now delayed for a year. The Securities Industry and Financial Markets Association and the American Securitization Forum complained that the changes, which could affect as much as $11tn of off-balance-sheet entities, may make companies appear short of capital to regulators and lenders. This does not help market confidence! Regulators and auditors should insure that these exposures are covered by capital reserves ratios to all risk weighted assets. Meredith Whitney, CIBC analyst, and highly influential scourge of banks' performance who has received death threats for accurately predicting bank writedowns, even she also wants to delay the introduction of accounting rule FAS 140 until 2011 or 2012. She says, “These moves to bring off-balance-sheet assets back on balance sheet for the sake of transparency are a mirage. The primary assets that will come back on to balance sheets are credit card loans. Frankly, there is more transparency in off-balance-sheet master trust data than in on-balance-sheet accrual accounting. Banks cannot afford it now and it will further constrain credit." This is the same she who wanted “banks and investment banks either to unload their problem loans and mortgage securities or to 'get real' about how they're valued”? Investors remain fearful. Banks' words are not their bonds! Government, Fed, FDIC & Treasury, have stepped in with generous modifications to loan contracts (to keep mortgage payments within 38% of household income. The UK Government is doing similar, even more generously, offering 3 year mortgage payment holidays to mortgagees who experience a sudden drop in income or have lost their jobs. These loand modifications may have a modest positive ratings impact on prime Residential Mortgage-backed Securities, and subprime, Alt-A and Option-ARM RMBS more so where over one third are defaulting and could now re-mortgage in effect during the worst of the recession - but this may not improve the prices of these bonds. Loan modifications could encourage (bring forward earlier) more delinquencies, negating pricing benefits, except if viewed in the wider roundabout context of macro-economic benefit. By placing a back-stop on delinquencies, one effect will be to dissuade vulture funds of the value of buying RMBS at say 25% of face value in expectation of a 55% minimum debt recovery from selling foreclosed properties. Standard & Poor’s Ratings Services recently quantified the potential impact of loan modifications on U.S. RMBS. The study examined four 2006-vintage transactions from each product sector that displayed average collateral characteristics and four that displayed adverse performance, subjecting them to a broad range of test scenarios. Key findings:
• Some transactions may see benefits in the form of fewer write-downs and improved ratings from successful loan modifications. However, investors should consider the potential loss in yield from the reduction in the loan interest rate and/or principal amount as a consequence of loan modifications.
• Although interest-rate reduction can potentially provide the greatest benefit as far as reducing borrowers’ monthly principal and interest (P&I) payments, we think that the most frequently used loan modification strategy will be some combination of interest-rate reduction and principal forgiveness.
• We believe that the combination strategy will be most effective because borrowers might still walk away from a mortgage, even with a lower payment, if the value of the house is less than what they owe.
• While interest-rate modifications may result in lower overall collateral losses, a reduction in interest rates may also reduce the amount of excess spread available in the transaction to protect against future losses, which may ultimately increase principal write-downs to the securities.
• Generally speaking, the senior securities for all product sectors retained greater credit support (the lower classes saw fewer write-downs) and experienced some ratings benefit from our loan modification scenarios.
• Most of the subordinate classes from the sample subprime, Alt-A, and pay option ARM classes benefited from fewer write-downs due to loan modifications, but did not experience any significant improvement from a ratings standpoint.
There are so many supposed 'moral hazard' accusations flying about, there should be no pecial reason to worry about one here; mortgagees will hold onto the debt and still be liable for the debt, even if the cost of this debt is lower in the short to medium term. It may mean mortgagees having to hold onto houses longer when prices do recover before they find themselves back in positive equity compared to others - so what?

Credit Crunch Subprime Recession: How long?

Readers may recall my prediction a few weeks ago that US recession probably started in the Winter 2007. I explained that it takes time for GDP data to be corrected and revised (major revisions possible for up to 2 years, mainly due to lateness in getting all profit/loss, unearned income and spending data in). I expect UK recession will be back-dated to the Summer of 2008 and EU recession (currently official) data to be revised and pushed forward, not back, to end of 2009. The US NBER has now confirmed the first part of that prediction stating that revised data suggests recession started in December 2007. Now that US economy is officially in recession, the big question on everyone’s mind is, how long will it last? Given that US recession (which may come to be called the Credit Crunch or Subprime Recession) is officially already 12 months old, the current recession is the fourth longest in the past 80 years and some others predict therefore it is on track to be as long as recessions in the ‘70s and ‘80s i.e. four quarters, 16 months. We are a long way from the Great Depression, which lasted 43 months or 3.5 years. On Monday, Ben Bernanke made a speech saying it is not useful to compare the current recession with the Great Depression because that was much worse. In looking at the above chart from WSJ we have a cluster of recession duration data, and an outlier (the Depression). The use of an overall average makes sense i.e. typically 9 months to crash and 72 months to recover to pre crash values. Or, we have an average duration for downturns unrelated to the long-term credit cycle, and another longer duration for small-sample downturns representing unwinding of te credit (crunch) cycle. The following is the U.S. long-term credit cycle chart (from SocGen). There are many clues for pondering the timing of the credit /business /economic cycle. Calling the turning point is not easy. The debate is often couched in terms of whether the recession will be V, U or L shaped. Gauging the magnitude of the financial sector's ills on top of the economic is the problem. I estimate them both to be of equal strength. Fiscal & monetary policy actions on top of guarantees, sureties, asset swaps and direct investment in banks by Government I calculate will cut the problem in two halves. Monetary and Fiscal measures are essentially aimed at mitigating normal recession while financial sector measured aim to restore banks to a more normal condition whereby they can play a part in recovery by maintaining a reasonable (and economically realistic) level of lending. There is a problem if the banks and the so-called 'real economy' do not respond intelligently and recession is therefore longer than usual, say 2-3 years! The conventional assumptrion is that banks will recover 55% of their booked losses, which may be somewhat at the upper end of past experiences. Various attempts by profilers to characterize the cycle are throwing out confusing signals. Different economic and financial measures are making different forecasts that adjust as the data is revised about timing of the economic contraction. Has it only just begun, in the middle or the beginning of the end?Depending on the data one chooses to highlight, all three scenarios look plausible.
Consider the chart below (courtesy of NoSpinForecast.com), published a few weeks ago. Setting aside the NBER's announcement, a simple review of earlier GDP numbers suggested economic activity peaked earlier in 2008 (Q2 posted a 2.8% annualized real rise in US GDP). The casual observer might think that Q3's -0.5% fall in US GDP (when UK posted a 0.3% rise) was the start of the recession, with most economists saying Q4 will suffer a bigger decline and 2009's looking weak. If we are in a V-shaped recession it should look like this. Non-farm payrolls are often resorted to in the US as a main cycle indicator. Year-over-year comparisons of this series have a habit of diving sharply ahead of the trough. The labour market has certainly been weak, 2.5 million jobs lost in the past year or so, not counting those who are unemployed do not yet qualify to register as unemployed, suggesting that a peak may have passed? Year-over-year comparisons of non-farm payrolls tend to coincide with periods when the economy's at its worst. Alternatively, stock market prices are signalling that we are deeper into the cycle and close to the cyclical bottom than GDP or payrolls suggest. The stock market has a history of falling ahead of the trough. Then there is the spread between long and short rates, signalling that the economic trough is behind us and the recovery phase has begun. The yield curve tends to invert ahead of the trough. But, the curve has inverted on and off for several years? The naïve explanation suggests the economy is set to rebound soon. But soon could mean the middle of next year just as in the UK the Government predicts recovery starting at the back-end of next year. The above metrics should be in sync for identifying where we are in the business cycle. This time, there is more variety in the reading the tea-leaves. In a year when rules of thumb and other prudential measures such as standard risk gradings have appeared to fail or look perverse, our challenge is determing which metrics harbour faulty unreliable signals. One valid question on reflection is why has the market been so stupid as to over-sell stocks so far below their book value? One reason may be the extreme experience of the opposite, the dotcom bubble, when investors prices Tech stocks far above their net present value or book value, pricing some in $billions that were generating mere millions in revenues. Then too the bubble in residential and commercial real estate. Two years ago, the all-knowing market bid up commercial property rates to 3%-4% rental return and in residential often below 3%. Dividend yields of 3% on REITs were rationalized as appropriate because of the infinite growth in lease rates ahead. Today, dividend yields on REITs are around 15%, just as profit ratios to share prices on many stocks are double this. Commodities were pumped up sometimes tenfold compared to prices today. Oh, but the market got banks right in the summer and they tanked, or was the market hijacked by short-sellers? Less than two years ago, junk spreads were at all time lows. Emerging market sovereigns were trading as if they were on the verge of becoming developed world credits. The near-perfect information markets were telling us how low solvency risks are and that liquidity risk had been abolished in a free flowing globalised world and how we were in the middle of the strongest period of co-ordinated global growth in history. Today, the markets are throwing babies out with the bath water. Risky assets are deemed too complex, therefore too risky, in a back=to=basics cash-is-king world, putting them up at fire-sale prices for the vulture funds to buy as never before. From junk bonds to investment-grade bonds to stocks to commercial real estate, anyone with a time frame longer than my nose is able to buy distressed assets from insolvent owners at 70-80% discount from pre-crisis values.
If you are playing the long game as a trader, this is a horrible market, probably more downside to come. If you are playing the long gsme as an investor, the market is offering up what is a one in a generation (some say once in a lifetime) opportunity to buy.