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Credit Crash Britain

In a series of special reports the Money Programme team investigate the issues that are affecting all of our bank balances: Credit Crash Britain.

Of all the UK casualties of the ‘Credit Crunch’, HBOS (Halifax Bank of Scotland) is to date the biggest and most significant. The planned takeover of HBOS by Lloyds TSB, announced to stunned financial markets on Tuesday 16th September, marks the demise of two giants that have dominated the UK financial sector for centuries. The Bank of Scotland was formed in 1695 and was the first commercial bank in the UK. The Halifax Permanent Benefit Building and Investment Society was founded in 1853. Prior to its demutualisation and conversion to banking status in 1997 the Halifax was, by some distance, the largest building society in the country.

We are too close to these amazing developments to understand exactly how the Bank of Scotland and the Halifax, united by the merger to form HBOS in 2001, found themselves being forced into a rescue by Lloyds TSB – a rescue that the Prime Minister himself took a central role in instigating.

Much has been made in the media that HBOS was a victim of ‘short selling’ by City traders. This practice which involves selling stocks that are not currently owned with the view of buying them back in the future at a lower price is a common trading strategy. The view held by some commentators is that aggressive short selling of HBOS’s shares drove down the share price to the point where public perception was that the bank was in trouble. With the Government and the Financial Services Authority  not wanting a repeat of a ‘run on the bank’ that we saw with Northern Rock in 2007, with savers queuing to get their cash out, the authorities acted swiftly to end HBOS's independent existence.

By placing it in the ownership of Lloyds TSB, the hope was that some semblance of confidence in the banking system would be restored. Given the size of HBOS – at £681 billion of assets it is seven times larger than the Northern Rock was when its problems surfaced in September 2007 – the Government simply could not contemplate a nationalised solution to the problem. Given the perceived impact on HBOS’s share price of the alleged short-selling the Government and the FSA also moved quickly to outlaw the short selling of the shares of other financial institutions.

Was HBOS a victim of short selling or rather an institution that weakened itself through its impaired business strategy?

But was HBOS a victim of short selling or rather an institution that weakened itself through its impaired business strategy? Many observers have pointed to HBOS’s growing reliance in recent years on wholesale funding from the world’s capital markets which made it, like Northern Rock, vulnerable to the illiquid conditions we have seen in the wholesale markets since the emergence of the US sub-prime mortgage crisis in summer 2007. Additionally HBOS was active in enlarging its share of the UK mortgage market just at the point that house prices peaked. The subsequent marked fall in prices has left HBOS vulnerable to bad debts as borrowers with negative equity default. There have also major losses in treasury assets – investments in asset-backed and other securities which have fallen in value in the wake of the sub-prime collapse.

Given the business backcloth it was perhaps hardly surprising that the process of raising more capital by the £4 billion ‘rights’ issue of new shares in HBOS was troubled with many investors refusing to take up their rights to further shares. This also was a factor which placed doubts in the minds of investors about the worth of HBOS’s stock - doubts that became reinforced by the reduction in dividends being paid out.

So was the reality that it was investors - particularly the fund managers - who brought on HBOS’s demise simply by dumping an increasingly unattractive stock? This seems more plausible than simply blaming the bank’s demise on ‘short sellers’.

The bank will be a colossus in the retail financial market with 142,000 employees and a 28% market share

Whatever the cause the outcome and consequences of the takeover by Lloyd TSB are huge in more senses than one. The bank will be a colossus in the retail financial market with 142,000 employees and a 28% market share - in fact if it had not been for the crisis conditions competition law would not have allowed the takeover to take place. The risk of such dominance is that Lloyds TSB will now have greater power to set the prevailing levels of mortgage and savings rates in the UK.

A further consequence is that there will be substantial job cuts given the overlaps between the two banks - for example in the branch networks and in the ‘back-office’ processing businesses.

For Scotland the blow is potentially substantial - both economically and to the country’s self confidence since, with the Royal Bank of Scotland, the Bank of Scotland dominated the Scottish banking industry. Lloyds TSB has, though, pledged to keep jobs in Scotland, retain the use of HBOS’s headquarters in Edinburgh and continue to print Bank of Scotland bank notes.

HBOS building.
[image by JohnConnell, some rights reserved]

Additionally the disappearance of the Halifax - predating by just a few days the rescue of the Bradford & Bingley - represents the failure of the demutualised building society business model. All those societies that converted to banks amidst much heralded plans to grow their businesses and explore new avenues for making money have now, within a handful of years, lost their independent existences.

At the time of writing, however, the approval for the takeover by the shareholders of Lloyds TSB has still to take place. In the light of the further collapse of the share price of banks globally in late September and October, and the move by the UK government to recapitalise the banks, a renegotiation of the original terms of the takeover inevitably had to take place. Under the revised terms made public on 13th October HBOS shareholders will receive 0.605 Lloyds TSB shares for each HBOS share. Additionally up to £17 billion of capital may be invested in the combined institution by the Government.

The amount of State finance will be determined by the shortfall in the demand by existing shareholders for further shares in the banks offered to them via forthcoming ‘rights’ issues. Given the distinct possibility that a substantial proportion of HBOS could end up being owned by the Government - making Lloyds TSB itself partially nationalised if it absorbs HBOS - there remains the risk that Lloyds TSB’s shareholders may not have an appetite for the takeover.

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About the author

Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

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In the first blog in this series I discussed the lamentable failure of Europe and the UK to develop start-up companies into large gorilla-sized organisations similar to American companies such as Microsoft, Intel, Apple, Oracle and Google. Apart from a few recent exceptions, such as Vodafone, Nokia and SAP, Europe and the UK have lagged far behind. A number of plausible reasons why UK and European technology companies have failed to become world-beaters on the same scale as their US counterparts have been forwarded and include:

• A lack of appropriate funding and tax arrangements
• The absence of a large homogeneous home market
• An inability to bring products rapidly to market
• A lack of entrepreneurial culture and spirit

Doug Richard.

The current UK scenario, however, is not all doom and doom as the Cambridge University technology cluster, famously known as Silicon Fen, starts to come of age after thirty years of development. According to Doug Richard, founder and chairman of Library House and former judge on Dragon’s Den:

“The Cambridge cluster has just tipped over and a period of explosive growth is ahead. It manages to attract a very large quantity of capital without variation”. 

Cambridge has already spawned a number of successful £1bn companies such as Arm, Autonomy and CSR radio. So do we have a Silicon Valley in the making or is this simply California dreaming? If Silicon Fen is to provide a lead role in nurturing the next generation of “gorillas” there are still a number of obstacles in its way. For example:

• There is a tendency for early stage entrepreneurs to exit their businesses through trade sales rather than undertaking a public flotation (this usually means selling-out to a larger US firm). According to Walter Herriot, head of St. John’s Innovation Centre in Cambridge: “If too many Cambridge companies are acquired by foreign companies the people and the intellectual property will disappear”.
• There is a tendency for European venture capital groups to invest smaller sums than their US rivals. The differential can  sometimes be as high as 50%.
• There is a failure of leading UK companies to invest in entrepreneurial start-ups. Cisco invests in start-up companies which benefit from the funding they receive whilst Cisco gains access to cutting-edge research.
• There has been a failure on the part of European stock exchanges to attract young companies. Neither the LSE nor AIM are considered to be as attractive as the Nasdaq where new listings are able to achieve higher valuations.

Another way of interpreting the superior growth trajectory of US start-up companies is the American business culture itself. Europeans do not lack technical expertise (and Silicon Fen is living proof of this) but does Europe have the same level of ambition and attitude to risk as the USA? According to David Wither, CEO and founder of UK technology company Sarantel:

“In the US, you know from the start you are on your own. Nobody is going to look after you – there is no healthcare or safety net. It breeds a competitiveness, which is part of the culture.” 

It might also be said that UK and European entrepreneurs are acting wisely by avoiding head-on competition with major organisations by adopting niche and complementary strategies, thereby avoiding conflict with larger rivals. This was a lesson that was learned by the pioneering UK personal computer companies such as Acorn, Sinclair and Apricot. Another interpretation is that by selling out early UK entrepreneurs are behaving in a totally rational manner. True serial entrepreneurs are good at starting and growing businesses but not well equipped to professionally manage them, so their early departure is not such a bad thing after all.

The problem is that they are not being acquired by other UK or European companies or as Walter Herriot, head of St. John’s Innovation Centre in Cambridge once commented: “I am slightly concerned that we are selling off the family silver”.

So should Europe be written off as a promising location for technology companies and is Silicon Fen really on hold until key obstacles are removed from the equation? 

Further reading

• 'Fen tries to be a valley' by Maija Pesola in the Financial Times on 16th Feb 2005
• 'The fertile soil of Silicon Fen' by Maija Pesola in the Financial Times on 9th Feb 2005
• 'Why progress requires ambition and risk' by Alan Cane in the Financial Times on 11th Feb 2005

About the author

Nigel Walton is an associate lecturer for the Open University and the University of Worcester, specialising in strategy, entrepreneurship and international marketing. He previously worked as a management consultant, primarily advising medium-sized companies with growth problems.

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In recent weeks the BBC’s business editor Robert Peston has come in for criticism about his role in breaking stories of banks in trouble (see for example these stories in the Daily Mail and Guardian).

Peston was the first to break the story of Northern Rock’s shortage of cash. The bank had enough assets to cover its obligations, but the credit crunch was making it hard for them to manage day to day operations. Peston’s story was quickly picked up by other news media. In the days following, queues of customers wanting to withdraw their savings from Northern Rock became so large at times that police had to manage crowd control. The bank’s operational difficulties, on which Peston had reported, quickly turned into a crisis of epic proportions. 

In normal times banks can safely accept savings deposits on terms which allow rapid withdrawal, then lend that money longer term. Deposits and withdrawals tend to average out and temporary imbalances can be covered by borrowing from other banks. But if unusually large numbers of depositors want their money at once, the cash is just not there. The system works because we trust it. Our money is safe so long as enough of us believe it to be. The breaking story about Northern Rock’s difficulties did not just reflect events it played a substantial role in bringing them about.  This pattern has become familiar as the current financial crisis has unfolded; news has not just followed financial events it has often amplified them.         

Robert Peston.
[image by SouthbankSteve, some rights reserved]

Of course the title of this article is mostly a rhetorical flourish. It would be unfair and untrue to accuse Robert Peston of single-handedly causing a recession. However, it is very much the case that media stories on the current turmoil are not just reflecting events they are also creating them.

Two ideas from social psychology and sociology can be helpful in understanding what is going on here: social amplification and performativity.

Social amplification of risk is the process though which public perceptions of risks can be produced and magnified as a consequence of the ways in which hazards come to public attention. A key issue in social amplification is the interest key parties have in the story. For example, media outlets have an interest in generating high circulation or viewing figures and ‘scare stories’ sell. This media focus on generating headlines can thus be a key factor in amplifying risk perceptions. Indeed the Daily Mail's outrage at the influence of Robert Peston might be seen as a little hypocritical given that paper's role in amplifying risk perceptions of other kinds, not least in relation to health.

If I drop a rock, it will fall to the ground (or perhaps on my toe) whether I believe in gravity or not. Gravity is independent of my belief in it. But many ‘facts’ I believe in are social facts and are true only so long as enough people believe in them; the value of money for example. What you believe does not just reflect our social world it helps create it. Performative statements or beliefs are those which help bring about the conditions they describe.

What you believe does not just reflect our social world it helps create it

The beliefs we subscribe to about banks are performative. By trusting that banks are safe places to keep our money we help bring about the stability which makes this true. By trusting each other with funds, banks ensure the stable operation of financial systems which in turn helps make that trust justified. Equally though, when we withdraw trust we help bring about conditions in which trust would be ill advised.

What we all think and feel about our financial security will have important consequences over the next few months. If we mostly fear the future, stop spending, withdraw our savings from banks, this will be part of the process which makes our fears true. Likewise as businesses take a view on the future and take decisions about investment and disinvestment, new hiring and layoffs these decisions will have a part to play in bringing about the future market conditions which that view is based on.

The media have an important role to play creating this future; they are not just disinterested bystanders. Whether they like it or not, journalists are not just reporting a financial crisis, they are performing it.

For a detailed account of social amplification at work in relation to a wide range of public risks see here. [Please note this link is to a 2.63 MB pdf document which may take longer to download with some internet connections] 

A recent book examines the role of performativity in economies and financial markets: Do Economists Make Markets? By Donald A. MacKenzie, Fabian Muniesa and Lucia Siu published by Princeton University Press.

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

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If the misery of the poor be caused not by the laws of nature, but by our institutions, great is our sin - Charles Darwin

As Governments worldwide commit billions upon billions of currency to save the banks and our national and international financial systems, spare a thought today for the humble poor. Last week Prime Minister Gordon Brown committed £500 billion to save our struggling banking sector from its own greed and avarice. Of course you could argue that if the international financial system collapses, the poor will be poorer, and there will be far more of them, but it is strange how governments - when pushed by uncontrollable forces which threaten their future - are spurred into desperate action.

Our world leaders have shown far greater alacrity in resolving the banking crisis than they did during the Making Poverty History campaign this time last year. Will the poor, as the Bible remarked, "always be with us" (John 12:8)?

In a world where food costs are spiralling their prospects appear bleak. Earlier this year, before the implosion of the world’s financial systems, the OECD reported that many developed countries had already cut back on their foreign aid budgets. When the going gets tough in the West the developing world is often is the victim. In times like these the words of 2006 Nobel Prize winner Muhammad Yunus ring true:

‘poverty has been created by the economic and social system that we have designed for the world. It is the institutions that we have built and feel so proud of, which created poverty for them.’

Two months ago the World Bank warned that the world’s poor were far greater in numbers than they first estimated. The Bank shifted the poverty line from a dollar a day to a dollar twenty five cents. It is amazing what adding a ‘quarter’ does to the projections: a mere 25 cents plunges a further 500,000 million people in the developing world into poverty. Thus it was that the World Bank’s new estimate of its poor rose in August from 985 million people to 1.4 billion people. This new estimate does not take into account the recent increases in food and fuel prices.

Oxfam, commenting on the World Bank figures, warned that a further 100 million people in the developing world could be forced into poverty by the increase in food prices. They also warned, in respect to the lack of progress on African poverty, that the pledges made by world leaders at the Gleneagles summit in 2005 to double aid to the continent by 2010 were unlikely to be met. The new estimates also take no account of the impact of the world financial crisis in the coming months on the vulnerable developing world where debt repayment to the West is a huge concern.

In early October, when Dick Fuld the chief executive of Lehman Brothers - the investment bank whose collapse did so much to trigger the crisis in world financial systems - was quizzed by Congressional leaders, he did not spare a thought for those billion people living in the world today on around a dollar a day. No. He talked about his compensation package. Defending accusations of a $500 million dollar pay off he contested its size: "The $500m number is not accurate, although it is still a large number," he told an angry Congress hearing. Wait a minute, 500 million dollars! That is one dollar for every human being in the developing world who have now been added to the poverty index.

The World Bank’s grim forecast revealed world poverty to be more persistent than at first thought. There is, however, some positive news.

Given the increase in world population, the rate of world poverty has fallen substantially from 50% to 25% over the past 25 years. But the number of people in poverty has increased. In Africa, between 1981 and 2005, the number of people in poverty rose from 200 million to 380 million, with the average poor person living on around 70 cents a day.

Unlike other regions of the world, the rate of African poverty has remained the same, around 50% of the continent’s population remained in poverty in 2005, compared to 1981. In Asia, however, the rate of poverty has fallen since 1981, from 60% to 40%. Asia is home to 595 million people living in poverty; 455 million of its poor live in India.

In China, poverty has fallen dramatically, from 835 million in 1981 to 207 million people in 2005. Its rate of poverty fell massively from 85%to 15%. The World Bank estimate that China alone almost accounted for all the reduction in world poverty since 1981.

World poverty, excluding China, dropped from 4 out of 10 people to 3 out of 10 people during the same period. According to the World Bank the world is still on track to halve the 1990 poverty rate by 2015. But at the current rate of progress, about a billion people will still live below $1.25 a day in 2015, and some areas, such as Sub Saharan Africa, will be acutely affected. [The World Bank’s new poverty line of $1.25 per day in 2005 is equivalent to its $1 per day poverty line introduced in 1981 after adjustment for inflation.]

Elsewhere, especially in those middle income countries where the World Bank uses a poverty line of $2 a day the poverty rate has indeed fallen. Latin America, the Middle East and North Africa have improved but not enough to bring down their total number of poor. The $2 a day poverty rate has increased in Eastern Europe and Central Asia though these areas showed some small signs of progress since the late 1990s.

We live in a world in which ten children die every minute from malnutrition, where 10.7 million children never live to see their fifth birthday, and where 4 out of 10 human beings have no access to basic sanitation. These are all avoidable statistics.

Meeting the United Nations’ millennium goal to halve the proportion of people in the world without access to clean water would cost $4 billion dollars a year for the next decade. Four billion dollars is roughly what Europe’s population spends each month on bottled water.

As the world struggles to understand why the financial systems have failed so abjectly, it is worth remembering the words of Dean Hirsch. On September 28, 2008, the President of World Vision International reminded the West that there was a possibility of them failing to fulfil the Millennium goals set in 2000 to help the world’s poorest people. He declared:

‘Our collective challenge – governments, the private sector, humanitarian organizations, civil society groups and others – is to remedy a gross violation of the most basic rights – to clean water, adequate food, basic health care – that currently leads to millions of children and women dying annually from easily preventable causes. This is a moral imperative. Every child who dies in extreme poverty represents an unacceptable loss of human potential.’

Some may, of course, choose to write to Dick Fuld, to advise him what he could do with his compensation package.

This blog is part of Blog Action Day 2008: Poverty

About the author

Richard Skellington edits Society Matters for the Faculty of Social Sciences at the Open University. He’s an administrator who manages the Environment, Development and International Studies programme.

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 ‘Where any view of money exists’, wrote William Blake, ‘art cannot be carried on’, giving lie to this claim is Danish artist Lars Kraemmer who founded the Bank of International Artmoney (BIAM) in 1997. Situated in the Copenhagen suburb of Frederiksberg, the ‘Bank’ is both gallery and clearing house for the production and circulation of ‘artmoney’, an alternative currency now traded by around 1000 artists, buyers and businesses around the globe.

Struck by the recognition that everyone is trying to ‘make money’, but no-one literally does, Kraemmer saw the production of artmoney as a practical means of stimulating trade amongst struggling artists who couldn’t otherwise afford to pay their rent or buy art materials – a modern revival of traditional bartering.  But also critical of the cold and objective nature of conventional transactions, Kraemmer devised artmoney as a means to a more humanised and ‘expressive’ type of monetary exchange. Not only was each artmoney to be designed as a unique work of art, but was intended to bring people together in affective, rather than impersonal, forms of trade.

Artmoney can be produced by anyone registered with BIAM and, like conventional currencies, has some standard rules of design. Artmoney must measure 12x18 cm (in order that it resembles a banknote) and only durable materials may be used. Each piece of artmoney must show a serial number, the year of production, the url for BIAM and the name, signature and nationality of the artist. The only other proviso is that artmoney must be an original work of art. Like conventional currency, artmoney has a market price. Each piece of artmoney is purchased for 200 Danish Kroner (about £20 or 26 Euro) and increases in value by 5 Euro per year for 7 years, with the increase in value being redeemable only when purchasing art from artmoney artists. When spending artmoney in other places, each piece retains its original value, regardless of the year of production – inflation being accounted for by periodic revaluations (when launched ten years ago each piece was worth 100 Kroner).

Once produced, artmoney can then be used like standard currencies. It can be used in exchange for goods and services (Kraemmer claims to have bought his stereo, computer and fridge with artmoney and used it to finance a trip around America).  Currently around 50 registered businesses (including cafés and bars, galleries, various retailers, even a psychotherapist) also accept artmoney as part payment for goods and services, at a rate determined by the individual business. There is also a host and guest programme where artmoney can be used to pay for travel accommodation.

But why would conventional businesses accept non-legal tender? According to Kraemmer, traders may be motivated by the opportunity to own a piece of original art,  touched by a desire for more meaningful exchange relations or simply amused by the quirkiness of the concept. As the BIAM website idealistically claims, using artmoney to pay for goods and services ‘will help bring people together in an intimate private situation’, offering ‘the chance for new friendships among strangers from all over the world’. And while it might be some time before we see Asda and B&Q accepting artmoney, the number of firms buying into this sentiment is steadily rising. 

the purpose of artmoney is to make art accessible and money meaningful

But is artmoney art? There is no denying the beauty and craft of artmoney (and that exhibitions of artmoney have proved popular with the critics and attracted collectors) – but since anyone can produce it (providing they stick to the given rules) there is plenty of artmoney in circulation in which even the most generous of critics would struggle to identify any artistic merit. For BIAM, such concerns are beside the point – the purpose of artmoney is to make art accessible and money meaningful. Bringing art into the hitherto mundane world of exchange helps overcome the modern separation of ‘art’ and ‘everyday life’ and also restores a sense of creativity, uniqueness and humanity in the exchange relationship. Stimulated into conversation by simple acts of ‘natural’ exchange, people become part of something communitarian and internationalist in focus – in this respect individual artistic ability is less important than using art to enhance sociability and communication.

Currently, however, it seems artmoney is in fiscal crisis. The project suffers from a surfeit in the ‘money supply’ but a shortage of ‘aggregate demand’ - indeed the project is in some danger of folding. Funds are also required since BIAM is currently embroiled in legal disputes with Danish authorities over the legitimacy of its use of the term ‘Bank’; a problem which highlights that the (now jail-threatened) Kraemmer has achieved at least one of his aims – to expose the politicised character of finance by challenging the state monopoly on the production of money.

So while in this time of credit crunch and impending recession, the idea of playing the currency markets might not appeal, people could speculate on a little artmoney. They would be helping artists and may well get themselves a mini-masterpiece - and if not they could always try and spend it on something else.

For further information see www.artmoney.org.

About the author

Mark Banks is Reader in Sociology at the Open University. His research interests include the cultural and creative industries, popular culture, cities and urban space.

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