I had the pleasure of being on Newstalk last week with Eamon Keane and during our brief chat I had mentioned that banks are lending out money cheaper than they can buy it, this was mentioned back to me by a client and he wanted to know if it was simply a slip of the tongue, because banks of course, do not lend money at a loss.
In fact that is precisely what is happening at the moment because the 3 month Euribor – which is the rate banks generally are buying their money at- is at 4.742%. Several banks are lending at less than this price namely NIB, Halifax, Bank of Scotland, Bank of Ireland and PTsb. So how is this happening? How can any CEO let their institution lend money at a price that will cause shareholder loss?
I suppose it’s down to a few factors, firstly banks don’t HAVE to buy money at the 3 month Euribor rate, they may be operating on the 1 month money which is currently selling at 4.349%, or they may be using any deposit reserves, typically they are paying 4% or less and are lending out at a higher rate, so in this instance 4.7% is still a decent profit. Investor and commercial loans are also bearing the brunt of the credit burden because residential mortgage rates are staying down while investor loan margins are increasing, commercial loans are normally Euribor linked so they have to pay more as a matter of course.
Banks are talking about increased cost being a reason for cutbacks, they are colluding to reduce broker commissions, job layoffs will follow, and the HR opaque area of contractors has not been examined. Banks often use contractors in their I.T. areas and in various other roles, there is no way of telling who will or won’t get their contract renewed and in a down market these workers don’t have the same set of rights as permanent employees so I suspect we will see them getting short end of the stick in many cases.
Other lenders are trying to ‘call the bottom’ and in some way rejuvenate a market that has had its confidence severely shaken, the Eurozone is feeling the pinch as well, certainly the trading figures from Germany where retail sales are down 1.6% was a huge shock to the financial community and it is only now, on the back of concrete information like this that the ECB may step in with a stimulative rate move. However, and you heard it hear first – when these cuts come some banks will not pass on the decreased rate to clients. Why? Because unless the interbank rates are coming down then profits will be hit as reserves dwindle during the present liquidity crush.
The short term compression on rates will have to have a market effect at some stage and this is visible in the UK where First Direct have stopped lending. In the USA lending is almost at a standstill and then there have been huge bailouts sponsored by the Fed. If you are under the impression the Fed can bail out all and sundry think again, the market cap of the US equities market is just over 4 trillion, the market cap of the Fed is about 1 trillion so they can’t just go on fixing things forever, the market will have to self heal at some point.
One thing that we may be seeing while bottom calls are being made is the bottom of the buck. The US dollar is in its worst bear market in history. The Fed has been called in several times with emergency moves to help out, even evoking laws that were designed during the Great Depression in order to do so, but the quick inflation and sinking dollar can only go so far before something gives.
For a start the Japanese Yen has been performing well despite an uninspiring economic situation there, this is likely because the Yen is a ‘safe’ currency and traders have moved into it as a dollar hedge, business in Japan must be feeling the effect of a strong Yen, for instance, it makes their car exports more expensive, and the Tankan Survey carried out by the bank of Japan shows that sentiment in that nation is running low.
Yen futures are now dropping in value, and the Euro (sometimes referred to as the anti-dollar) looks set to drop too, the reduction of interest rates would possibly help reduce strength and its this coupled with inflation being where it needs to be and figures showing a slow down in economy that may prompt the ECB to deploy a rate cut. The merest possibility of a rate cut made the Euro fall against the dollar.
Thankfully lending is still working well in Ireland and the international credit crisis is not affecting Ireland and Irish mortgages the way it is in other countries, however, it doesn’t mean that the rate cut which is now (finally!) becoming more likely will alleviate borrowers on variable rates, the money market prices on Euro short sells indicates that the belief is out there that a rate cut is coming, the interesting thing will be to see if that rate cut finds its way into the consumers pocket!