Latest Bank Actions Draw Comparisons To 1929 Crash
With all the upheaval in the global economy lately, comparisons were bound to be made with another era symbolic of financial hardship. Last weekend, Philip Aldrick of the Telegraph (UK) wrote:
Perhaps the most intriguing parallel, though, is the crude attempt at self-preservation made by the investment trusts in 1929 and the banks now.
In the great crash, investment trusts with vast cross-holdings in each other tried to stem their collapse by buying up their own stock in what the economist JK Galbraith in his book, The Great Crash 1929, described as an act of “fiscal self-immolation”. At the time, “support of the stock of one’s own company seemed a bold, imaginative and effective course,” Galbraith wrote, but ultimately the trusts were just “swindling themselves”.
Yet, as I often bring up from time to time, the American writer Mark Twain once said, “History doesn’t repeat, but it often rhymes.” Aldrick notes that almost 80 years later:
Modern economists have compared the trusts’ actions with what the banks are now doing. “They seem to be just papering over the cracks,” says Brendan Brown, chief economist at Mitsubishi UFJ Securities.
To free their books of the estimated $1,000bn (£505bn) of sub-prime assets and $340bn of leveraged loans banks have been left carrying since the credit markets shut down last year, lenders are offering to sell these damaged assets cut-price and - crucially - are willing to lend investors the money to buy them. In other words, the banks are providing new debt for the old debt they no longer want.
At first glance, as with the investment trusts, the arrangement seems little more than trickery - recycling a bank’s own funds back into its own assets. As one senior industry expert described it: “It is like walking through a hall of mirrors in a fairground. There are far fewer people who really understand it than profess to understand it. Even the central bankers don’t know where all the risk is ending up.”
The Telegraph reporter highlighted a number of examples where banks provided funding for the purchase of debt or subprime assets they own:
• UBS sold a $22 billion portfolio of subprime assets to American fund manager BlackRock
• A consortium of banks financed last year’s £9 billion Alliance Boots merger by offloading £2 billion of the debt to private equity
• Citigroup and Deutsche Bank are each believed to have offloaded $10 to $12 billion of U.S. leveraged loans in recent months, partly funding the purchase themselves. Aldrick noted that these banks, along with Merrill Lynch, have found buyers for “tens of billions of dollars” of their subprime debt, using similar funding arrangements.
Ingenuity, or a disaster in the making?
Source:
“Banks’ credit crisis solutions have echoes of 1929 Depression”
Philip Aldrick
Telegraph (UK), June 1, 2008
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