Morning:
8°c
So whom do you believe? Do you go with the board of Barclays, which coupled its profit figures yesterday with the confident assertion that it was on top of the problems in the credit markets, knew what its exposures were and had them so under control it felt able to raise its dividend? Or do you go with Credit Suisse, which last week made a statement remarkably similar in tone to that of Barclays - and then yesterday said it had "discovered" a clutch of assets that were overvalued by about $3 billion (£1.5 billion)?
The conflicting fortunes of these two banks go to the heart of the current malaise in the markets. The perception, rightly or wrongly, is that the banks themselves do not know how bad things are. They may give assurances they have their arms firmly round their problems so there will be no more nasty surprises. Then they produce another nasty surprise.
Comforting as it would be to believe Barclays, it is not the way to bet. For a start, the G8 leaders said 10 days ago that the fallout from the crisis could reach $400 billion of losses. But the banks so far have only confessed to $120 billion of losses (plus $3 billion more from the Swiss), so we are barely a quarter of the way through. Where are the rest of the horrors?
It would help if one knew where the $400 billion figure came from because arguably even it is on the low side. The valuation problems have contaminated the whole world of credit default swaps and, as the New York Times reported the other day, you can add together the value of the US Treasury market at $4.4 trillion, the US mortgage market at $7.1 trillion, the US stock market at $21.9 trillion, and it is still less than three-quarters of the outstanding value of credit default swaps, which is $45.5 trillion. To save you doing the maths, $400 billion is less than 1% of $45 trillion.
Now admittedly these are gross not net figures, a lot is hedged, a lot is matched, and a lot doesn't really exist anyway. But as of now, people really don't know how to value that derivative stuff. Until they do, how can we believe that the banks are on top of their problems?
ONE of the good things about Northern Rock was that when it demutualised, it used the windfall surplus to create and endow a charity, the Northern Rock Foundation. It has received 5% of the bank's profits every year since - money it has used to support a raft of good causes in the North-East and to be a significant force for good.
Provision has been made to keep supporting the charity in the short term, but its future is clouded. Its rules state that the shares it holds in Northern Rock should convert into 15% of the bank's equity in the event of a change in control - which presumably includes the bank being nationalised. Chances are that the converted equity will be worthless, which must raise a question over the charity's ability to continue long term.
This raises a broader issue of diversification. When a charity is endowed, is it right that it should remain locked into the founder shares and have its fortunes permanently tied to the parent that provided the endowment? Or should trustees be allowed to take the money and spread the risk around?
A couple of weeks ago, the Wellcome Trust, a charity created by the founder of the eponymous pharmaceutical company that is now part of GlaxoSmith-Kline, announced that, thanks to its inspired investment policy, it would be able to increase its grants for medical research by 60% to £4 billion over the next four years.
The relevance here is that the trust originally was entirely shares in Wellcome and, had there been no change, it would now be entirely in shares of GlaxoSmithKline. However, several years ago, the chairman of the trustees, Roger Gibbs (whom many will remember as the inspirational head of Gerrard & National in the days when the City had discount houses), felt it was too risky to have all the eggs in one basket, and unsentimentally decided the shares should be sold and the cash reinvested. This paved the way for the spectacular results delivered by current investment manager Danny Truell - results quite independent of Glaxo's fortunes.
What is doubly interesting is that in an earlier age Gibbs' father had been chairman of the Nuffield Foundation, the charity endowed by Lord Nuffield aka William Morris, inventor of the Morris car. Nuffield refused, however, to allow his shares to be sold, so when Morris Motors eventually became part of British Leyland, that was where the charity's money went too - with inevitably sad results.
It is too late now for Northern Rock, but other charities would do well to heed the lessons of history.
