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24 hours that shook the financial world

By: BILL BLEVINS

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Bill Blevins is Managing Director of Blevins Franks. He has specialised in expatriate investment and tax planning for over 35 years. He has written books and gives lectures on this subject in Southern Europe and the UK.

ON AUGUST 19, the International Monetary Fund’s former chief economist, Kenneth Rogoff, delivered a stark warning about the credit crisis:   “We’re not going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one, one of the investment banks or big banks”.

Prophetic words.  Less than a month later, after a turbulent 24 hours, two of Wall Street’s biggest banks are no more. Lehman Brothers filed for bankruptcy and Merrill Lynch is being taken over by Bank of America.  

At the same time, news also broke that American International Group (AIG), the world’s largest insurer with a 1,000 billion US dollar balance sheet, was also in trouble after suffering losses from its exposure to real estate.  

BBC’s business editor, Robert Peston, described it as Wall Street’s most extraordinary 24 hours since the late 1920s, with Merrill Lynch’s sale being almost as shocking as Lehman’s demise.    

Shares plummeted as the news broke across the world. Just a week earlier they had responded positively to the news that the US authorities had seized control of mortgage giants Fannie Mae and Freddie Mac.

Confidence in financial institutions around the world was severely shaken. Financial institutions are much more vulnerable to sudden withdrawals of liquidity or loss of confidence.

Just a few days later, HBOS had to be rescued by Lloyds TSB in a 12bn Pounds Sterling takeover after share prices and confidence in HBOS fell dangerously.  On Wall Street, share prices for Morgan Stanley and Goldman Sachs plummeted, leading to speculation that they are looking, or will start to look, for potential buyers. In response, the UK’s Financial Services Authority banned “short selling” of bank shares and the New York Attorney launched an investigation into illegal manipulation to profit from short selling. The US Congress unveiled a plan to buy up toxic assets, such as bad mortgages, held by troubled banks and other institutions, hoping to lift the nation out of its worst financial crisis in decades.  

Lehman Brothers

Investment bank Lehman Brothers is a 158 year old firm and one of the Wall Street’s largest and most respected institutions.  

On September 9, its shares fell 45 per cent.  On the 10th it reported a 3.9bn US Dollars loss for the third quarter.  On the 11th its shares dropped another 42 per cent.  On the 12th increasingly desperate talks were initiated between Wall Street executives, US Treasury secretary Hank Paulson and president of the New York Federal Reserve Tim Geithner, attempting to resolve the situation before it damaged confidence in the US banking system.  

However news wires soon reported that Paulson refused to commit taxpayers’ money to saving Lehman. Then potential rescuers Barclays and Bank of America pulled out after the US government refused to provide certain guarantees. In the early hours of the 15th Lehman announced that it was filing for Chapter 11 bankruptcy. (Barclays has since struck at two billion dollar deal to buy some Lehman assets out of the bankruptcy proceedings)

The bank has 639bn US dollars of assets and 613bn dollars  of debt.  It has creditors throughout the US, Europe and Asia.

Merrill Lynch

Merrill Lynch chose to avoid the same fate by surrendering its independence to Bank of America (which had just decided not to buy Lehman).  The board voted unanimously in favour of the 50bn dollar takeover. The merger was agreed in less than 48 hours after the bank had seen its shares fall by a third the previous week.  

The spotlight is now on Morgan Stanley and Goldman Sachs, which could soon become the only two independent investment banks in the US.

AIG  

AIG has been destabilised by 18bn dollar losses on mortgage investments.  

While Paulson had been adamant that taxpayers’ money should not be used to bail out Lehman, after high level talks on the 16th the Fed agreed to extend an 85bn dollars bridging loan to the insurance giant, in return for a 79.9 per cent stake and effective control of the company.  

The Fed acted to prevent a “disorderly failure of AIG” which would have seriously damaged the stability of the financial system.

Savers

Savers are being advised to limit the amount they deposit with a single banking group to that which would be covered under whatever deposit guarantee scheme applies to that bank.

The UK’s Financial Services Compensation Scheme (FSCS) guarantees 35,000 Pounds Sterling per person per group of banks for deposits held within a bank authorised by the Financial Services Authority.  For overseas branches of UK banks FSCS compensation will depend on how the deposit taker is authorised to provide services.  Jersey, Guernsey and Isle of Man are not in the European Economic Area and are not covered.

The Isle of Man’s Depositor Compensation Scheme will cover 75 per cent of up to 20,000 pounds per depositor.  Guernsey and Jersey do not have a guarantee scheme.

In Spain a maximum of 20,000 euros is protected and in Portugal 25,000 euros.  

Even prior to the Lehman collapse there had been significant outflow of funds from many banks as reputations fell and depositors perceive increased risk.  Many instead elected for higher rated money funds paying decent rates of interest and often held in tax planning vehicles where tax is reduced.  Anyone concerned at the current state of affairs should discuss cash deposit alternatives with their financial adviser.

To keep in touch with the latest developments in the offshore world, check out the latest news on our website www.blevinsfranksinternational.com