Banks

Unhappy new year

More banks reveal damage caused by subprime-infected debt

HOW big the final bill will be is not clear. But most estimates put the eventual tally for defaults by America’s subprime borrowers at $200 billion-300 billion. Sensibly with such a big sum, banks are taking the pain in installments. On Thursday December 20th Bear Stearns was the latest Wall Street bank to add to the $40 billion or so in related losses that its peers have admitted to. The bank suffered a write-down of $1.9 billion in the quarter to the end of November on its exposure to subprime-infected debt and a loss of $854m, its first ever in any quarter of its history.

The day before Morgan Stanley had released its own bad news, a whopping $9.4 billion write-down in the latest quarter. This led to Morgan Stanley’s announcement of its first-ever quarterly loss too, in this case of some $4 billion. John Mack, the bank’s chief said the results were “embarrassing” and will forgo his bonus for the year. James Cayne opted for the describing his bank’s performance as “unacceptable”. He and other top executives at Bear Stearns will also go without bonuses. And both bosses look more vulnerable.

Mammoth write-downs at Merrill Lynch led to the departure of its chief executive, Stan O’Neal. HSBC and Citigroup have both taken the step of absorbing off-balance-sheet debts. SIVs and conduits helpfully allowed banks to keep subprime investments off their balance sheets so they had no need to set aside capital in case of problems. Now they have turned sour the banks are having to face up to huge losses. But though the revelations of losses is now underway no banks is quite sure what liabilities other banks are sitting on.

This doubt has gummed up the interbank lending market. A lack of clear information has led to money-market funds cutting off loans which has forced central banks to prop up big banks by stepping in to provide extra liquidity. The latest intervention came on Tuesday when the European Central Bank said that it would make €350 billion ($500 billion) available to tide banks over the holiday period. Despite the activities of central banks, fearful financial institutions are having to conserve capital to offset the lack of short-term funds. And the interbank market will not recover until investors believe that banks have credibly owned up to all their losses.

Some banks have also taken to tapping fresh sources of capital. Citigroup obtained $7.5 billion from Abu Dhabi’s sovereign-wealth fund. UBS has taken a $9.75 billion investment a Singapore investment fund. On Wednesday Morgan Stanley tried to soften the blow of its loss by announcing the sale of a 9.9% stake to the Chinese government's sovereign-wealth fund, China Investment Corporation, for $5 billion. The next days press reports suggested that another state-owned investment fund from Singapore might also invest $5 billion in Merrill Lynch, which is widely expected to suffer another big write-down.

America has not always welcomed investment from abroad. In the summer of 2005 CNOOC, China’s state-controlled oil company, withdrew a bid for Unocal, a California-based oil company after uproar from politicians of all stripes over the damage it might do to America’s national security. Later that year DP World, a firm backed by Dubai’s government, was forced to pull out of a deal to acquire a slew of American ports after a similar reaction.

Desperation seems to have softened attitudes to accepting money from China and the Persian Gulf. Mr Mack was keen to point out that the Chinese fund would be a passive investor and that the decision was part of a strategic move to strengthen ties between the two markets. But Mr Mack also stressed that other bits of Morgan Stanley’s business are quite strong and that in spite of its losses, the bank would have been well-capitalised even without the Chinese investment. That admission could be cause for concern.

Although Mr Mack says that the extra capital will allow his bank to take advantage of new business opportunities another interpretation could be that the bank is shoring itself in the expectation of further trouble. The bank may reckon that it needs more protection from the ill effects of the subprime meltdown on the banking system.

If the credit squeeze spreads and borrowing becomes harder, not just for housing but across other parts of the debt markets (such as commercial property or credit cards) money-market funds could withdraw even further from lending to banks. Moreover a recession in America and Europe could magnify these problems as well as causing trouble of its own. The final reckoning could prove very painful indeed.