Show me the money

May 3, 2009 — Mitul Kotecha

The long awaited results of the US administration’s stress tests for US bank will be announced on May 7th. There have been various rumours and speculation about the details in terms of the extent that banks will require further capital injections and indeed which banks will need such injections. Ahead of the announcement I thought it would be an interesting exercise to look at the potential equity needed in the global financial sector.

Some light on this was shed by the IMF’s recent release of the Global Financial Stability Report in which the fund increased its total estimates of global writedowns to over $4 trillion. The most recent estimates of financial sector writdowns suggest that institutions are only about one-third of the way there.

In other words there is still a considerable amount of writedowns on toxic debt left to be undertaken. The IMF estimated further writedowns in the US in 2009 and 2010 at $550 billion, $750 billion in the eurozone and $200 billion in the UK.

Moreover, they estimate that financial institutions will require $500 billion of additional capital in the US, $725 billion in the eurozone and $250 billion in the UK just to raise the ratio of common equity to total assets (a measure of leverage) to 6%. Even these estimates may prove conservative. After all, the IMF has raised its estimates of total writedowns several times already and will likely do so again. These figures do not even include the need for other financing which when added amounts to around 60% of Bank’s total assets.

The bottom line is that even with all the money that is being provided to financial institutions at present it will be highly unlikely that they will be able to raise sufficient capital if the IMF’s estimates are anything to go by. Consequently balance sheets will contract sharply and deleveraging will continue.  Governments will be forced to provide support for a long time to come and the end result will be either outright nationalisation or alternatively bankruptcy for some institutions that are deemed not too big to fail.  Worryingly the risks are skewed on the downside, especially if the economic recovery is a weak one which I believe is highly likely to be the case.

Posted in bank rescue, Economics, equity markets, Europe, Financial crisis, UK, US, US administration. Tags: , , , , , , . Leave a Comment »

A taxing time in the UK

April 25, 2009 — Mitul Kotecha

It has been a truly gloomy week for the UK economy.    Firstly there was the shock budget announced by UK Chancellor Darling in which the scale of UK borrowing requirements became worryingly clear.  To summarise briefly the government expects tax revenue to come in at around £175 billion or a whopping 12.4% below public spending in this fiscal year.   What’s more the bulk of this is structural or persistent so will not be erased without adding another layer of taxes. 

It will take several years to reduce the budget gap according to the budget estimates, with the government predicting that the deficit as a percent of national income will drop to 1.2% by 2017-18 but this relies on highly ambitious forecasts.  The scale of government borrowing required and the reliance on government bonds to bridge the gap is worrying enough and has caught the attention of ratings agencies.   It also effectively rules out further stimulus should the economy turn even more sour than expected or if anticipated recovery does not take effect.    

The bigger problem is that the deficit reduction plans bank on highly optimistic and probably downright unrealistic growth growth forecasts.    This was demonstrated by data released shortly after the budget announcement revealing that the economy shrank by a much bigger than expected 1.9% in the first quarter of this year,  the worst growth outurn since the third quarter of 1979.    So much for hopes that the worst was over at the end of last year.   Although the government has said that this does not alter their budget forecasts, as they are based on growth for future months, it does reveal that they vastly underestimated the depth of the recession in the UK.  

Even the forecasts for economic growth in the next few years look highly ambitious with the pace of contraction forecast to ease over coming quarters and stabilise by year end.   Further out, if growth does not pick up as forecast there is a real risk that not only will tax rates not be reduced for several years but that the UK taxpayer is destined for even higher taxes for years to come.     

There has much press on the increase in the high rate of income tax from 40% to 50% but the reality is that this will only bring in a small amount of revenue and will do little to close the gap between spending and tax revenues.   It will require a substantial easing in spending for the government’s plans to have any validity.  It appears that the aftermath of the bursting of the debt fueled consumer spending bubble is still being felt and will continue to do so for years to come, much to the expense of the taxpayer.

Posted in Bond markets, Economics, Financial crisis, UK. Tags: , , . 1 Comment »
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