Monday, 9 February 2009

A bad Barclays

According to Robert Peston, Barclays' share price appears not to reflect the underlying state of the bank. It raised £10bn in new (private, not public) capital last year and made £6bn in pre-tax profits (between £4bn and £5bn post-tax). Thus, in theory, its balance sheet should contain around £15bn of new capital since this time last year. Not to mention whatever was on there before.

And yet, its shares are valued at under £9bn. Presumably this is because of uncertainty about the value of some of its assets, and the fear that they will be written down - eliminating the capital base of the bank.

So why doesn't Barclays take - on its own initiative - the advice many economists have given to the US government, and create its own "bad bank"? It could simply split itself into two or more pieces, with the better half of the assets in Bank A and the riskier half in Bank B; and provide the minimal required capitalisation to bank B. B would carry off a big chunk of capital but, on the basis of the accounts, by no means all of it.

Bank A, "good Barclays", would be left as a strong and low-risk institution whose market value would surely exceed £9bn; Bank B, "bad Barclays" would be much riskier, but even if its shares became completely valueless the shareholders would be better off.

This might not be "playing fair" - it would risk shoving the liabilities of Bad Barclays onto the government - but it would surely be in the interests of the shareholders, who are so far still in control of the bank. And, arguably, in the interests of the economy by providing at least one large, secure, well-capitalised bank capable of providing credit to willing borrowers.

5 comments:

justeconomics said...

The reason the can't do this is because the new "bad bank" would have to be financed entirely with equity. Where is this equity going to come from? The good bank. So we're back to where we started.

For example if Barclays had $10 of equity and $90 debt to support $100 of assets (figures invented), and $10 of its assets were bad, then in order to split, the good bank would have no equity value at all!

Meanwhile the bondholders (who lent the $90) would lose their claim on the bad assets even if they returned only a minimal amont. So they'd never permit it.

More at: http://competitivemarket.blogspot.com

Leigh Caldwell said...

Hmm, kind of. I gather that Barclays' equity is actually substantially higher than it needs to be to finance the current asset base (according to the bank's own evaluation of the riskiness of its portfolio). Therefore it should still be possible to split off some equity and leave the remainder sufficiently capitalised.

However, as you say it is quite likely that the bondholders have some power to veto the divesting of assets, and this would probably prevent such a scheme from going ahead. Even in the absence of this provision, the government would no doubt use informal means of applying pressure to stop it.

justeconomics said...

So what exactly are we trying to accomplish?

The problem with these bad assets is not that they have negative value but that they might be worth $0.

By creating this bad bank, all you've done is removed from Barclays the chance to recover anything more than $0. Since your plan gives that equity to the current shareholders, the only people being screwed are bondholders. Yes, the government can apply pressure, but unless the government pays for this, it's essentially a confiscation of property.

Without a new infusion of cash (from the government or elsewhere), moving the assets won't work.

What banks should have been doing all along and failed to do is mark to market accounting. Had all the banks who are in trouble now properly marked their positions, they would have been able to manage their capitalization more effectively. Instead you've got this nearly fraudulen situation where Barclays can tell its investors that its assets are worth 100% when they are substantially less by any meaningful standard.

What really needs to happen is that the equity holders need to be wiped out as do junior debt holders and so on up the ladder until there is sufficient equity. The current owners of the company are entirely responsible, both morally and financially to whatever happens to Barclays and they should be punished and not the taxpayers of the UK.


More at: http://competitivemarket.blogspot.com

Leigh Caldwell said...

I think we are in agreement. My "suggestion" is purely a tactical idea that I suspect Barclays shareholders or management might consider.

It's not likely to be in the interests of either the taxpayer - except that it may force the issue of confronting the old debts, avoiding a Japan-style situation - or of Barclays' creditors. For that reason I wouldn't seriously propose this as a stable solution.

You have highlighted that, if anything, this is probably a warning to Barclays creditors that the equity holders may have an incentive to try a scheme like this, and that the creditors should watch out for it. It's another example of the market providing an opportunity for particular parties to create a structure that's profitable for them while the risks are borne by someone else.

Ravi said...

Perhaps you should post on competitivemarket.blogspot.com, the author has great posts, however not a lot of traffic has been coming to the website.