Bradford & Bingley- UK Mortgage Bank to be Nationalised

Dear Reader,

Bradford and Bingley's slow 12 month death march towards the same fate as Northern Rock finally looks set to have come to an end with expectations on Sunday that the beleaguered bank will be nationalised with a view to a break of the bank and liquidation of assets so as to cover in part the estimated £20 billion bailout cost that is required to fill the gap between assets and liabilities. The toxic mortgages will probably end up with the government owned Northern Rock bank which will increasingly be seen as the UK Governments Toxic Mortgage Dump where the tulip backed securities of further bank busts and partial bailouts will end up.

The demise of Britain's biggest buy-to-let mortgage bank, Bradford and Bingley (B&B) is not NEWS, but rather the inevitable outcome as I warned of over 12 months ago following the Northern Rock bust as the next in line for going bust given the banks huge exposure to the buy to let mortgage market. The news of the last 12 months has repeatedly supported this view that has in recent months seen an increasingly desperate FSA regulator trying to find a buyer for the bank as nationalisation is a disastrous last resort outcome that represents a FAILURE for ALL concerned, the bank, the FSA, the Bank of England and the Government. But it seems that no bank is willing to take over the bank as is, given the huge potential losses as buy to letters increasingly default on their mortgages in the wake of the UK Housing market crash that has accelerated over the summer, that was warned off as early as November 2007.

The B&B management has repeatedly proved inept during the last 12 months as though the banks officers were in denial of the calamity that faced the bank that continued to pump out rosy adverts months AFTER Northern Rock went bank bust, calling on more buy to let investors to take up mortgages, which are the first to jump ship as the UK housing market hit the credit crisis ice-berg and crashed over the summer months.

During July of this year, Bradford and Bingley was bailed out by the other UK banks as the FSA to all intents and purposes forced major UK financial institutions to underwrite B&B's rights issue of £300 million at 55p, as payback for the £100 billion of short-term loans, which itself was revised lower in the wake of the collapse in the banks share price from the initial rights issue price of 82p. However the share price crashed through the 55p issue price, settling at 30p. This meant that the under writing banks had to buy up much of the unsold stock at 55p and therefore sat on an instant loss of 45%. However this had the effect of delaying a nationalisation of B&B at the time as the bank gained some capital that has since been eaten away by losses.

The below graph illustrates recent events for Bradford and Bingley that bowed to the inevitable that was unequivocally clear on the price chart. The only surprise is that B&B outlasted HBOS for which the FSA did manage to persuade Lloyds TSB to takeover amidst an attack by Hedge Fund short sellers just over a week ago.

Chart Courtesy of Bigcharts.com

B&B Shares fell to a new low of just 16p on Friday which represents a value of just £240 million, a mere 2.5% of the peak value of the bank of some £9 billion about 18 months ago. Speculation of a rescue of the bank has been growing ever since Lloyds stepped in to buy Britain's biggest mortgage lender HBOS. However the situation is clear late Saturday that no financial institution is prepared to touch B&B with a barge poll, even if the price tag is a mere penny, the bank would still bring a baggage of approx £20 billion in ultimate losses, more than enough to wipe out any buyer.

Whilst there has been no overt run on the bank along the lines of Northern Rock during Sept 07, however savers spooked by the biggest mortgage bank in Britain on the verge of bankruptcy and following day after day of the worlds biggest investments one after another either going bankrupt or being taken over to prevent bankruptcy, B&B has obviously sustained a loss of customer depositors over the preceding week, which may turn into an avalanche of withdrawals come Monday if the Government does not make an announcement on Sunday that the bank has been to all intents and purposes nationalised pre-breakup and distribution of the profitable arms amongst other UK banks whilst the losses are stuck with the tax payer. So a potential windfall for some lucky banks!

UK Deposits and Savings Are Secure

At the present time the first £35,000 ($65,000) of UK savings are 100% secure. The UK government had proposed following Northern Rock bust to raise this to the first £50,000 by the end of 2008. However as we saw with the Northern Rock, when the government stepped in to guarantee the first £100,000 of savings to bring the bank run to a halt, that the consequences of fear that savings are not 100% secure would lead to the panic spreading to other banks and hence a collapse if the whole banking system amongst a wave of bank runs. Therefore this suggests that if the worst came to the worst that the Government would step in to secure 100% of savings on at least the first £100k with immediate effect. However at this time, to be on the safe side it is probably better to continue to limit exposure to any single banking group to no more than £35,000 until the actual government announcement of extension.

How can the Banks be Going Bust ?

The question I am most asked is how can banks be going bust due to just a few subprime mortgages. Without going deep into the whole history and sequence of events which led to the current situation which dates back to Japan entering into an economic depression, deregulation of capital markets during the 1990's in the wake of the collapse of the Soviet Union and the deflation of cheap chinese goods coupled with manipulated government inflation statistics. Followed by the Dot com crash and post Sept 11th deep US interest rate cuts which ignited the housing bubble, with similar deep rate cuts amongst other western economies.

The reason why the banks are going bust in simple terms is:

The banks traded in complex derivatives products between themselves, in what is termed as the over the counter market. The exposure to the Securitized debt packages was further exaggerated by the use of leverage of in many cases more than 30X the banks assets against valuations based on complex models that inflated the packages values during the boom times which allowed huge profits and bonuses to be banked (Fraud?). However the critical point is in the final link in a long chain of sliced and diced debt packages was the US housing market.

As US house prices fell, the gap between the real value and the banks inflated model values to boost profits grew, until the crunch point last August when it dawned on market participants that in actual fact they did not have a clue as to the real value of these mortgage backed securities and hence the credit markets froze as no one wanted to buy something they could not value and nor lend to financial institutions that may default on their obligations. The impact hit all banks, whether or not they had exposure to the US housing market, as those whose business model relied heavily on short-term money markets to finance long-term mortgages were in deep trouble, i.e. Northern Rock and to a lesser extent ALL of the other UK mortgage banks.

Now many banks are left with assets that are worth less than 50% of their booked value. Now that does not mean a 50% loss for the banks on investments, remember the greedy banks deployed LEVERAGE of as much as 30 times of assets, so capital of say £100 million is controlling risk of as much as £3,000 million. Therefore a 50% loss results in a loss of value of £1,500 million., that's 15 times the capital. Hence the banks have been reluctant to price their debt packages at the market price as that would mean the bank is effectively bankrupt with losses far greater than the banks capital base. So the market remains frozen until all of the illiquid mortgage backed debt has been transferred to the tax payers in exchange for liquid cash, hence prompting the US Mother of All bailouts plan.

So basically you TWO related problems at work driving the banks bust:

1. One of collatorised debt that is not being valued at market prices, hence frozen money markets with banks sitting on over leveraged time bombs that have started to explode in recent weeks.

2. Mortgage banks reliant on short-term money markets to finance long-term mortgages that threw caution to the wind and loaned far too much money to people who could not afford to repay the mortgages are now being hit by increasing defaults as the western housing markets crash from over inflated levels, as their losses mushroom but now find that they are unable to borrow money to cover day to day operations due to the risk of default and hoarding of cash in advance of asset price mark downs. Therefore the only venue available is from the Bank of England or individual savers.

and there's more ....mortgage backed securities are the tip of the iceberg, the next inline are credit default swaps which are basically investor insurance to protect them against losses on the debt packages. However as we saw with collapse of and nationalisation of the worlds biggest insurer AIG, this is another huge part of the derivatives market that is imploding, perhaps in the region of $60 trillion. Its the reason why ordinary people are going to find problems with the credit card freeze next as defaults rise and retailers start to charge a premium on card transaction due to risk of default on the transactions, or even refuse to accept credit cards, but that has yet to happen..

United States Answer To Collapsing Banks is a $700 Billion Bailout Plan

Despite all of the noise of Congress's qualms that we will witness played out during the next 24 hours or so, the bailout plan will more or less pass . Despite the fact that it represents madness, an ultimate manifestation of the subprime contaigent spreading and infecting the US Treasury with all of the consequences of loss of confidence in ALL US paper as the value of US debt devalues in the eyes of all investors.

The US Treasury and Central Bank are eager to get the US Congress to pass a blank check bill so as much of the toxic mortgage backed bonds can be bought up to prevent a further collapse of the financial system. $700 billion is not enough, not in the face of the huge deleveraging of the $500 trillion dollar market, as I warned of 6 months ago. The $700 bailout plans two un-said objectives are -

a. To delay the potential of financial collapse until AFTER the November election,

b. That the real bailout cost will run to several trillion dollars, as the US government seeks to prevent a chain reaction of collapsing banks in the wake of counter party failures amongst the huge $500 trillion global derivatives market.

The latest tactics is to suggest that the US Tax payer may even make a profit on these toxic securities. The fact of the matter is that the US will probably be looking at a loss of over 50% on maturity of the anticipated price paid as there is no way that market prices will be paid, as primary reason for the freeze on the interbank money markets is that the securities are NOT being priced by the market for if they were then the market valuations would imply that the financial institutions are bankrupt, hence the free market has been suspended. Taking an estimated eventual exposure of some $ 2 trillions, therefore implies an eventual US tax payer loss of at least $1 trillion. Which is more than enough to send the US bond market toppling as the US is heading for a budget deficit of more than $1 trillion.

The real question that the peoples representatives should be focusing themselves on is how do we bring those who benefited from the greatest fraud in history to account for their actions and the possible repatriation of wealth stolen in recent years to the tune of more than $1 trillion due to huge bonuses paid on the back of boosted fake asset valuations. That would probably increase confidence in US paper than signing a blank check.

Is your Bank Safe ?

The US Fed's and other central back actions do not mean that banks will now be saved, as last weeks example of WaMu going bust, America's biggest bank failure illustrates that literally many hundreds if not a thousand plus banks will go bust during the course of the worsening credit crisis, with all of the consequences for depositors. The following report by EWI presents a list of the 100 safest US banks.

UK Toxic State Mortgage Bank

The ground work for the bank bailouts was laid earlier in March and April 08 on the announcements that the UK Government would loan £50 billion to the Banks in exchange for toxic illiquid mortgage backed securities in an attempt to unfreeze the interbank market , at the time I warned that this is just the first step and that eventual liability would extend to several hundred billions if pounds which would still be a drop in the ocean compared to the ongoing deleveraging of a 500 trillion derivatives market which has highly deflationary implications for the credit and asset markets as we have been observing in recent weeks.

First Northern Rock and now Bradford and Bingley mark Britain's own emergency government intervention of the bailout of toxic mortgage backed securities. The estimated UK tax payer exposure in terms of anticipated losses to date is about £40 billion, £20 billion for Northern Rock and £20 billion for B&B. This is in addition to the money loaned to the UK banks as a consequence of the freeze of the interbank money markets and represents a total tax payer exposure to of at least £150 billion, or some $280 billion which compares against the US tax payer exposure of approximately $1.2 trillion that takes into account the proposed $700 billion weekend bailout.

What can Savers do ?

The only thing that savers can do is to attempt to limit real terms losses as much as possible, this implies locking in fixed savings rates ahead of now increasingly anticipated interest rate cuts. The first port of call should be fixed rate cash ISA's which currently range between 6% and 7.3%. The next port of call should be Fixed rate bonds for at least 1year and preferably 2 years, in this case savers have a window of opportunity with rates ranging from between 6.3% to as high as 7.2%. The current market leader is ICICI Bank which pays 7.2% for terms of between 1 and 3 years. Remember to adhere to the limits mentioned above of £35k per banking group.

UK Housing Market

The implications for the UK housing market both as a consequence of the HBOS takeover and Bradford and Bingley bust are going to hit the mortgage market hard with both a reduction in supply of mortgages and an eagerness of the two banks to seek to reduce their mortgage books by trying to induce their customers to remortgage to other banks via higher mortgage interest rates and therefore reduce their risks of default in the wake of the ongoing housing bear market.

The Labour government has attempted to support the housing market by suspending the 1% stamp duty taxed on house purchases on properties up to a value of £175,000 for a period of 1 year and to support new house prices through Homebuy Direct Interest Free loans.

The Halifax's latest house price data shows that the housing market crash continued to accelerate into August, plunging by 1.7% that saw another £3000 wiped off house prices following the £3,300 write off for July to stand at down 12.8% on the year to August (on a non seasonally adjusted basis). UK house prices have now fallen by more than 8% since April. If a fall of 8% in 4 months cannot be considered a crash in UK house prices than I do not know what can. No wonder Chancellor Darling virtually threw in the towel recently in his famous "I give up, please let me spend more time with my family" speech.

The housing market's near 13% plunge in 12 months is having a severe impact on the whole of the UK economy, as falling house prices are directly impacting on the Uk economy in a like for like basis, after the Financial Sector those sectors closest to the housing market contracting the sharpest, followed by consumer sector and eventually echoing out through the economy. The only glimmer of hope is for the exporters as the British Pound itself crashed during the past few weeks.

Britain is facing the the PERFECT STORM of DEFLATION as the housing bear market erodes home owner equity by several thousands of pounds every month, and INFLATION in the input and output prices surging to 20 year highs. This has meant that instead of taking action to save the economy, save the housing market, the Bank of England has been paralysed since April of this year into inaction.The fact is the Bank of England does not have a clue of what to do so seeks to do nothing as the situation is far more complex than it appears on face value given the now open fact that most of the banks are bankrupt, insolvent ! , I had been writing on this topic for a good 6 months that no one was going to tell the public the truth, with the banks coasting from quarter to quarter announcing ever larger bad debt provisions and calls for government tax payers cash in exchange for near worthless mortgage backed illiquid toxic putrid slime until the crunch time came when all of the banks capital had been destroyed and the market was no longer willing to step in to finance further capital injections in the form of rights issues.

Therefore Britain is being pushed into a deep dark stagflationary recession which we look set to enter by the end of THIS year.

In the meantime, Gordon Brown having survived the recent assault in his leadership due to Financial Armageddon is still not out of the blue as 12 months from now the leadership challenge pressures will again reassert themselves into the lead up next years party conference.

Where Do House Prices Go From Here?

The current crash in UK house prices has been fore warned by myself several times during the last 12 months, right from before the housing market peaked in August 2007. An update has been pending for several weeks, which has been delayed due to the near apocalyptic events of recent weeks demanding more immediate intention. The intention remains to update the UK housing market to cover the next 2 years within the next 2 weeks.

Nadeem Walayat,
Editor of The Market Oracle

Copyright © 2005-08 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

For more in depth analysis on the financial markets make sure to visit the Market Oracle on a regular basis.

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