Car Finance Scandal Could Eclipse PPI, Warns City Regulator.
A lawyer from the FCA acknowledges that the extent of compensation may be greater than initially anticipated, potentially reaching levels comparable to PPI, which resulted in a £50 billion expense for banks.
Britain's car finance scandal has the potential to rival the payment protection insurance (PPI) mis-selling crisis, which resulted in a £50 billion loss for UK banks, as acknowledged by the chief legal officer of the City regulator.
Stephen Braviner Roman, the general counsel and executive director responsible for legal affairs at the Financial Conduct Authority (FCA), stated that the recent court of appeal ruling in October regarding car finance commission structures significantly broadened the possibilities for consumer compensation.
This pivotal ruling established that the practice of paying a "secret" commission to car dealers who facilitated loans, without revealing the amount and terms of that commission to borrowers, was illegal.
The decision extended beyond the FCA's investigation into a particular type of commission payment, referred to as discretionary commission arrangements (DCAs), which the regulator prohibited in 2021.
“We’ve previously said that looking at DCAs alone, we do not think it’s the scale of PPI,” Braviner Roman told MPs during a Treasury committee hearing on Tuesday. “But that was when we were looking at DCAs alone. So I think it would be premature to say it’s definitely not the scale of PPI now.”
The implications indicate that the expenses incurred by lenders, such as Lloyds, Santander UK, and Close Brothers, may exceed Moody’s projected figure of £30 billion.
Earlier this year, the chief executive of the regulator, Nikhil Rathi, downplayed the comparison, stating that he did “not anticipate this issue playing out as PPI did”. He had been making efforts to alleviate worries following remarks from Martin Lewis, the founder of MoneySavingExpert.com, who indicated that this situation could result in the largest compensation payout since the PPI scandal.
However, the ruling from the Court of Appeal has significantly expanded the scope of what was previously a limited investigation. The lenders implicated in the motor finance case, namely Close Brothers and FirstRand, the owner of MotoNovo, are currently seeking to challenge the ruling at the Supreme Court.
PPI represented the most expensive and protracted consumer scandal in Britain’s history. Approximately 64 million policies were sold in the UK, primarily between 1990 and 2010, with some dating back to the 1970s, often bundled with loans, mortgages, credit cards, and other financial products.
Regulatory authorities began imposing penalties in 2006 upon discovering that the costly insurance was frequently aggressively marketed and mis-sold by banks, which claimed that the policies would provide coverage in the event of illness or job loss. However, while these policies generated significant profits for the banks, numerous exclusions meant that many customers were unable to file claims.
The implicated lenders continued to pay fines and compensation to affected customers until 2019, resulting in a total industry cost of approximately £48.5 billion.
In the meantime, the chief executive of the FCA cautioned that the chancellor’s intentions to relax regulations and promote increased risk-taking in the financial sector would inevitably attract unscrupulous individuals.
“We can’t stop everything. If we’re going to allow more risk into the system … it sometimes does attract people who don’t have the best of intentions,” Rathi said.
Rathi was discussing the contents of the chancellor's remit letter, which indicated that initiatives aimed at consumer protection should not hinder "sensible risk-taking" within the financial sector. Rachel Reeves also called on the FCA to enhance its support for the growth and competitiveness of firms in the City.
The remit letter was dispatched shortly after Reeves spoke to bankers at the annual Mansion House dinner, where she asserted that the regulations established to safeguard the economy following the 2007-08 global financial crisis had "overreached."
Her statements have sparked controversy, particularly as Labour's lenient regulations were implicated in the downfall of the Royal Bank of Scotland in 2008. The failure of RBS intensified the global financial crisis, compelling the government to allocate tens of billions of pounds to rescue several banks, which subsequently resulted in years of recession and austerity throughout the UK.
The growing car finance scandal, with potential compensation claims rivaling the PPI crisis, highlights serious concerns about the financial industry’s integrity. As the scope of wrongdoing expands, many consumers may face significant financial losses, exacerbating the already strained relationship between banks and the public.
While some companies push back, challenging rulings and dragging out the process, the damage to consumer trust is undeniable. If the scandal results in the massive payouts predicted, it could cause even greater financial instability, leaving taxpayers and consumers to foot the bill once again, as banks continue to evade true accountability.
LATEST: ONS Warns Average Home in England Now Unaffordable.
A major lender to tech firms, the bank faced "inadequate liquidity and insolvency" as it scrambled to raise money to plug a loss from the sale of assets affected by higher interest rates, according to banking regulators in California. Its struggle set off a series of customer withdrawals and sparked fears for the wider banking sector.
The Federal Deposit Insurance Corporation (FDIC) said it had taken charge of the roughly $175 billion in deposits held at the bank, the 16th largest in the US. Many firms with money tied up in the bank have been left in uncertainty regarding their futures.
The bank's UK branch was put into insolvency from the evening of Sunday 12 March but swiftly rescued by HSBC for only £1 in a move praised by Krista Griggs, Head of Financial Services & Insurance at Fujitsu. “The UK technology industry is thriving and it requires a commitment to long-term success if the country is going to achieve its ambition of becoming a scientific and technology superpower," she said in a statement.
“HSBC’s fast response is a welcome move that will ensure continuity for businesses at risk from the collapse of Silicon Valley Bank. It shows commitment to innovation and I expect to see more involvement from traditional banks as they look to provide stability during disruption - as well as further union between them and FinTech companies as this sector continues to rapidly evolve."
The brutal reality is the Central Bankers understand the levers they pull no longer function as they once did. The stark reality is Central Banks have no answer to inflation except to hope and carry on. They are caught between the Scylla of inflation and the Charybdis of a market collapse. This is why so many analysts are confident the markets will win out and keep going higher because central banks have little choice but to keep up the stimulus.
Most of the market is fixated on what the S&P does, what new high the NASDAQ will make this month, or where Amazon is going to top this quarter. They have the vision of a blind man when it comes to anything much beyond the end of their one-year time horizon. Even the bond market seems blind. The market is so focused on the short-term and ignoring the consequences of the last 10 years of QE, monetary experimentation and easy rates, that it's blundering into the next crisis. Inflation matters, and it has jumped from financial assets into the real economy.
The reality is investment should be about the long term. If you ignore the future in favour of short-term gains, it makes it very easy to dismiss the evidence that inflation is actually a very real issue.
Lots of smart non-financial assets funds do understand that and see just how horribly distorted markets have become. That’s why they are so keen to diversify out of corrupted financial assets and into real assets, the hot part of the market.
Going back to inflation, the outlook is complex. For instance, it’s possible to argue the rise in commodity prices is a factor of hoarding. Manufacturers anticipating a surge are preparing for massive post-pandemic demand. The spikes in commodities from copper to lumber are now in reverse. This supports the market’s contention the inflation number is something of an overshoot.
Oil is an outlier. OPEC is a monopoly price setter but it is going through yet another of its periodic organisational crisis resulting in a spike that’s proving difficult to hedge. Owning oil is not a pleasant outcome for anyone as we saw last year when traders found themselves owning negative priced oil when storage was unavailable.
If you ignore the future in favour of short-term gains, it makes it very easy to dismiss the evidence that inflation is actually a very real issue.
There are some of the important underlying trends in the economy like used cars, where prices are rising. It hints that it is details of specific inflation factors in each price that are important. We’re all aware of the global shortage of chips enabling carmakers to cut production and create scarcity, pushing up new car prices, dragging second-hand values higher as consumers seek alternatives. On the other hand, new car prices have been rising for years, with higher costs “justified” by the increasing amount of tech junk put into them. As the EU announces it will outlaw new internal combustion engine vehicles by 2040, I wonder if we are going to see a new countertrend develop. To explain, consider the Land Rover. A 10-year-old low milage, full-service history, Range Rover in immaculate condition may be worth £16,000. A 20-year battered Defender with zero documents is worth £32,000. But you can fix it with Gaffa Tape, WD40 and a hammer.
However, inflation complacency may be the least of Central Bank worries. You may have spotted an increasing number of breathless articles from around the globe on House Price Inflation.
Everywhere on the planet the affluent classes - those with savings, who’ve done well from lockdown, and already on the property ladder – have been driving an uptick in property. It's debt-fuelled and an illiquid market. No one sells till they see what they want to buy, and the ladder is actually a pyramid, with fewer assets on each successively higher rung.
The result is record home prices nearly everywhere. This week US Fed Chair, Jerome Powell and US Treasury Sec Janet Yellen are going to chat about it at the Financial Stability Oversight Council. A body was set up in 2010 to identify excessive risks to the US Financial System after the financial crisis. About time. Housing is frothier than 2007 according to the Case-Shiller US property value index.
Rightly, Janet and Jerome are concerned a second housing bubble bursting could shake the foundations of finance again. However, this time will be different. The housing market is not vulnerable to a massive number of low-credit-score mortgagees defaulting, but to a large number of affluent middle classes suddenly finding themselves financially stretched, on a rung of the ladder they can’t afford, and sitting on negative equity when the bubble bursts.
In the UK, we live with negative equity. In the US, you walk away. Whatever, these consumers consume less.
The structure of the market has also changed. Banks don’t lend anymore. They broke their risks off to the investment sector. In the case of US mortgages, the risk is pushed back to the government through the Mortgage-Backed Bond buyback schemes, and to the non-bank financial institutions that now finance, originate and service mortgages.
This is going to be the really big problem of the next stage of the Global Financial Crisis. Smart money has been loading up on real assets on the basis they are decorrelated from the increasingly corrupted financial asset sector, but the reality is real assets from property, private equity, secured lending, aircraft, shipping, you-name-it, is now getting just as frothy as a result of all that inflation tied up in financial assets now spilling into the real economy.
Financial Asset Inflation has infected the real economy.
New figures from the Office for National Statistics (ONS) have shown that UK GDP fell by more than 20% between April and June. Following on from a drop of 2.2% between January and March, this means that the UK has now officially entered a recession.
The 20.1% drop in quarterly GDP exceeded that of all other G7 nations; France’s GDP fell by 13.8%, followed by Italy at 12.4%, Canada at 12%, Germany at 10.1%, the US at 9.5% and Japan at 7.6%. It is also the steepest recorded contraction since the ONS began collecting data in 1955.
In an interview with Sky News on Wednesday morning, Chancellor Rishi Sunak attributed the contraction to the “composition” of the service-based UK economy, which was heavily affected by the COVID-19 pandemic and resultant lockdown measures.
“Social activities, for example going out for a meal, going to the cinema, shopping, those kinds of things comprise a much larger share of our economy than they do for most of our European comparative countries,” he said.
“So in a situation where you have literally shut down all those industries for almost three months, a long period of time, it is unfortunately going to have an outsized impact on our economy.”
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Commercial data and analytics firm Dun & Bradstreet have updated their predictions for the UK economy in 2020 following the new figures’ release. Their updated forecasts now predict a 9.8% drop in real GDP for the year.
“Dun & Bradstreet’s latest proprietary data for Q2 shows that payment performance has deteriorated across all 14 sectors tracked during the pandemic, despite several quarters of continuous improvement prior to lockdown,” wrote the firm’s chief analyst, Markus Kuger. “During the coming quarters, it will be more important than ever for businesses to assess potential credit risk across their existing and future business relationships.”
The basic definition for a recession is a decline in GDP over two consecutive quarters. The UK has not experienced a recession since the 2008-2009 financial crisis, which saw a peak quarterly dip of 2.2% in GDP – just over a tenth of the plunge recorded for Q2 2020.
Paresh Raja, CEO of Market Financial Solutions, examines the impact of the SDLT holiday so far and the importance of reinvigorating the property market.
With a value of £1,662 billion, the UK’s real estate market is a vital contributor to economic growth and productivity. That’s why the government’s plan to support the UK’s post-pandemic recovery has focused so heavily on real estate. After all, it was one of the first sectors to benefit from the initial easing of social distancing measures, ensuring that buyers and renters were once again in a position to move homes and initiate new property transactions.
Most recently, Chancellor Rishi Sunak took the bold step of announcing a new Stamp Duty Land Tax (SDLT) holiday applicable to all property transactions until 31st March 2021. The government estimates that this will see average SDLT bill cut by £4,500, with nine out of 10 buyers purchasing a main residential home exempt from the tax.
The move aims to encourage buyers back to the real estate market, and so far, it has been having measured success. Estate agencies have noted a spike in enquiries – importantly, these enquiries range from first-time buyers to non-UK residents seeking a buy-to-let property. While it is too early to tell whether the holiday will bring about a stable and sustained increase in real estate transactions, the fact prospective buyers have acted immediately following the SDLT holiday announcement is promising.
With a value of £1,662 billion, the UK’s real estate market is a vital contributor to economic growth and productivity.
Unlocking the full potential of the SDLT holiday
The SDLT holiday provides the financial incentives needed to reignite interest in property, but one feels it will only have limited success. This is because homebuyers will still struggle when it comes to finding the right type of finance needed to complete on a sale.
When lockdown measures were first introduced, mainstream mortgage providers decided to retreat from the market by limiting their product and service offerings, freezing new applications and delaying the deployment of mortgages already agreed to in principle. This had dire consequences for those in the middle of a property transaction, increasing the risk of chains collapsing.
In response, brokers and borrowers turned to established specialist finance providers who remained committed to meeting the needs of the market. Bridging loans became a popular option due to their speed, flexibility and ability to be tailored to the individual needs of each borrower. While transactions did decline during lockdown, a proportion of those completed was due to specialist finance.
Now, banks and mortgage providers are once again returning to the market. However, the range of mortgage products available is still limited. There are also fears that these traditional lenders will only deploy loans for a handful of cases in order to minimise their risk exposure. Indeed, there are already reports of banks not deploying mortgages to borrowers who take advantage of the COVID-19 loan repayment holiday scheme.
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Just like we saw in the aftermath of the global financial crisis (GFC), it is during times of economic recovery that the need for creative solutions that support growth and stimulate investment are needed. And similar to what we witnessed in the months and years following the GFC, specialist finance is rising to the call by ensuring that homebuyers are able to act confidently and quickly.
At this critical moment, it is important that buyers and property investors have access to the finance needed for new home purchases. This requires research and a full appreciation of all the products and services available beyond just the high street.
Failing this, there is a real risk of the SDLT holiday only having limited success.
In the aftermath of emergency measures outlined by both governments and banks worldwide, US and European stock indexes saw an increase in value after a week of uncertainty.
The Dow Jones rose by around 1.5% after a rocky start as trading opened, while the S&P 500 and Nasdaq Composite climbed by 1.3% and 2.4% respectively.
Meanwhile, London’s FTSE 100 rose by 3%, and the European STOXX 600 index rose by around 4%. Germany’s DAX also increased by 5%, and France’s CAC 40 by 4.7%.
The increased optimism seen in these markets can be credited to stimulus measures on the part of central banks. In Europe, the ECB pledged to buy €750 billion worth of bonds in a bid to defend the eurozone from the expected damage of the coronavirus epidemic, a move which French president Emamanuel Macron said was sorely needed by “our people and our economies”.
These measures coincided with the Bank of England’s decision on Thursday to cut interest rates down to their lowest level in history, from 0.25% to 0.1%.
Norway followed suit on Friday, with Norges Bank cutting interest rates to 0.25%, its own lowest-ever rate.
In the case of the US, the stock rise came after the Federal Reserve announced plans to temporarily provide billions of dollars to nine central banks suffering from greenback shortages, and at near-zero rates. Banks affected by the offer include the Bank of Korea, the Reserve Bank of Australia, the Reserve Bank of New Zealand and the Monetary Authority of Singapore.
Despite these measures, however, US indexes are still likely to finish Friday at their worst weekly percentage drops since the 2008 financial crisis.
As further quarantine and social distancing measures come into effect, slowing spending and prompting layoffs, it is likely that market uncertainty will continue.
Auditors have become punching bags for governments that have struggled to respond to the aftermaths of the financial crisis. Anger and distrust remains in the public domain. There is little sense of accountability for misconduct for executives or their intermediaries. The few trials against individuals have resulted in little to no jail time. Intermediaries such as bankers have gone largely unscathed.
The weaknesses in capitalism have never been felt with such intensity, so raw and painful. We are wrestling with issues of inequality, with dwindling expectations or hopes for more shared prosperity. Capitalism is rightfully under attack for delivering uneven prosperity and leaving so many behind. There are important voices in business such as Warren Buffett and Larry Fink who have been calling for more responsible leadership and investing to address the shortcomings. Amidst these daunting challenges, auditors present an easy target for governments to signal accountability and reform.
We must resist following myopic and uninformed views. Reforms are needed to make capitalism more effective. Audit reforms won’t prevent bad judgements in business or avoid governance and business collapses. The failure rates in auditing are extremely low in comparison to the number of audit opinions issued every day. That is not to say that processes within audit firms could not be improved, as identified from various reviews. But true audit failures – those where audit opinions missed material frauds and such failures led to business collapses – are exceptionally rare. Simply put, material accounting frauds are rare events and this has not changed in the last decade.
The weaknesses in capitalism have never been felt with such intensity, so raw and painful.
The limitations of financial reporting will inevitably remain and therefore the probability of future business failures occurring may not necessarily change by altering the audit market. Specifically, accounting is reliant on the historical cost convention and mark-to-market adjustments, based on rules set internationally. Additionally, the ‘expectation’ gap for auditors to be guardians against fraud will largely remain. When management and third-party collusion is involved, fraud, corruption, and money laundering will remain increasingly difficult to detect for an organisation’s internal controls and the best auditors.
The work ahead
Although questions remain about how to best implement reforms, it is clear that there are valid trust and credibility issues affecting the accounting profession that need to be studied and addressed. There is legitimate public anger and frustration from corporate failures. It is correct to demand that executives involved in misconduct (or who are wilfully blind to it) are held personally accountable and face prosecution. The same should apply to those that facilitate misconduct as intermediaries or gatekeepers.
Business and auditing failures have contributed to the erosion of trust and it is incumbent on all of us to restore trust in both business and its gatekeepers. The profession can and should take further steps to improve audit quality.
To find effective solutions, it is important to apply a more holistic approach and analyse concerns, issues and solutions in the context of the entire business and reporting ecosystem. Using auditors as punching bags today is distracting from the important reform work ahead to address the shortcomings of our current form of capitalism.
About the author:
José Hernandez is the CEO of Ortus Strategies and the author of the new book Broken Business: Seven Steps to Reform Good Companies Gone Bad (published by Wiley), which is available now in hardback and ebook.
Website: http://www.ortusstrategies.com/
There have been a number of high profile stock market crashes over the years often resulting in huge losses for both individual investors and businesses. Although there is no specific number that determines when a stock market crashes, a crash occurs when there is a significant decline in the share prices. Usually it becomes a crash when one of the major stock market indexes loses over 10% of its value. Most of the major stock market crashes are preceded by a long bull market and they often result in panic-selling by investors attempted to liquidate their stocks to avoid further losses.
The stock market fluctuates daily, but on some occasions the crashes can be seismic and cause long lasting effects. Here we take a look at 10 of the biggest stock market crashes in history.
1. The 1673 Tulip Craze
In 1593 tulips were first brought to The Netherlands from Turkey and quickly became widely sought after. After some time, tulips contracted a non-fatal tulip-specific mosaic virus, known as the ‘Tulip breaking virus’, which started giving the petals multicolour effects of flame-like streaks. The colour patterns came in a wide variety, which made the already popular flower even more exotic and unique. Tulips, which were already selling at a premium, grew more and more in popularity and attracted more and more bulb buyers. Prices, especially for bulbs with the virus, rose steadily and soon Dutch people began trading their land, life savings and any other assets they could liquidate to get their hands on more tulip bulbs. The craze got to a stage where the originally overpriced tulips saw a 20 fold increase in value in one month.
The 1673 Tulip Mania is now known as the first recorded economic bubble. And as it goes in many speculative bubbles, some people decided to sell and crystallise their profits which resulted in a domino effect of lower and lower prices. Everyone was trying to sell their bulbs, but no one was interested in buying them anymore. The prices were progressively plummeting and everyone was selling despite the losses. The Dutch Government tried to step in and offered to honour contracts at 10% of the face value, which only resulted in the market diving even lower. No one emerged undamaged from the crash and even the people who got out early were impacted by the depression that followed the Tulip Craze.
Tulip Mania; Image credits: Krause & Johansen
2. The South Sea Bubble 1711
Another speculation-fuelled fever occurred in Europe a few decades after the Tulip Mania – this time in the British Empire. The bubble centred around the fortunes of the South Sea Company, whose purpose was to supply 4,800 slaves per year for 30 years to the Spanish plantations in Central and Southern America. Britain had secured the rights to provide Spanish America with slaves at the Treaty of Utrecht in 1713 and the South Sea Company paid the British Government £9,500,000 for the contract, assuming that it could open the door to trading with South America and that the profits from slave trading would be huge.
This was met with excitement from investors and resulted in an impressive boom in South Sea stock – the company’s shares rose from 128 1/2 in January 1720 to over 1,000 in August. However, by September the market had crumbled and by December shares were down to 124. And the reason behind the bubble burst? Speculators paid inflated prices for the stock, which eventually led to South Sea’s dramatic collapse. The economy was damaged and a large number of investors were completely ruined, but a complete crash was avoided due to the British Empire’s prominent economic position and the government’s successful attempts to stabilise the financial industry.
Commentary on the financial disaster of the "South Sea Bubble"
3. The Stock Exchange Crash of 1873
The Vienna Stock Exchange Crash of May 1873, triggered by uncontrolled speculation, caused a massive fall in the value of shares and panic selling.
The National Bank was not able to step in and provide support because it didn’t have enough reserves available. The crash put an end to economic growth in the Monarchy, affected the wealth of bankers and some members of the imperial court and confidants of the Emperor, as well as the imperial family itself. It also led to a drop in the number of the Vienna World Exhibition visitors – a large world exposition that was held between May and October 1873 in the Austria-Hungarian capital.
Later on, the crash gradually affected the whole of Europe.
Black Friday on 9th May 1873 at the Vienna Stock Exchange
4. The Wall Street Crash of 1929
On 29th October 1929, now known as Black Tuesday, share prices on the New York Stock Exchange collapsed - an event that was not the sole cause of the Great Depression in the 1930s, but something that definitely contributed to it, accelerating the global economic collapse that followed after the historic day.
During the 1920s, The US stock market saw rapid expansion, which reached its peak in August 1929 after a lot of speculation. By that time, production had declined and unemployment had risen, which had left stocks in great excess of their real value. On top of this, wages were low, agriculture was struggling and there was proliferation of debt, as well as an excess of large bank loans that couldn’t be liquidated.
In September and early October, stock prices began to slowly drop. On 21st October panic selling began and culminated on 24th, 28th and the fatal 29th October, when stock prices fully collapsed and a record of 16,410,030 shares were traded on NYSE in one day. Financial giants such as William C. Durant and members of the Rockefeller family attempted to stabilise the market by buying large quantities of stocks to demonstrate their confidence in the market, but this didn’t stop the rapid decrease in prices. Because the stock tickers couldn’t handle the mammoth volume of trading, they didn’t stop running until about 7:45 pm. During the day, the market had lost $14 billion. The crash remains to this day the biggest and most significant crash in financial market history, signalling the start of the 12-year Great Depression that affected the Western world.
17th July 2014 Washington DC, USA - A detail from one of the statue groups at the Franklin Delano Roosevelt Memorial that portrays the depth of the Great Depression
5. Black Monday 1987
On 19th October 1987, stock markets around the world suffered one of their worst days in history, known today as Black Monday. Following a long-running rally, the crash began in Asia, intensified in London and culminated with the Dow Jones Industrial Average down a 22.6% for the day – the worst day in the Dow’ history, in percentage terms. Black Monday is remembered as the first crash of the modern financial system because it was exacerbated by new-fangled computerised trading.
The theories behind the reasons for the crash vary from a slowdown in the US economy, a drop in oil prices and escalating tensions between the US and Iran.
By the end of the month, stock markets had dropped in Hong Kong (45.5%), Australia (41.8%), Spain (31%), the United Kingdom (26.45%), the United States (22.68%) and Canada (22.5%). Unlike the 1929 market crash however, Black Monday didn’t result in an economic recession.
Following a long-running rally, the crash began in Asia, intensified in London and culminated with the Dow Jones Industrial Average down a 22.6% for the day – the worst day in the Dow’ history, in percentage terms.
6. The 1998 Asian Crash
The Asian crisis of 1998 hit a number of emerging economies in Asia, but also countries such as Russia and Brazil, having an overall impact on the global economy. The Asian crisis began in Thailand in 1997 when foreign investors lost confidence and were concerned that the country’s debt was increasing too rapidly.
The crisis in Thailand gradually spread to other countries in Asia, with Indonesia, South Korea, Hong Kong, Laos, Malaysia and the Philippines being affected the most. The loss of confidence affected those countries’ currencies – in the first six months, the Indonesian rupiah’s value was down by 80%, the Thai baht – by over 50%, the South Korean won – by nearly 50% and the Malaysian ringgit – by 45%. In the 12 months of the crisis, the economies that were most affected saw a drop in capital inflows of more than $100 billion.
7. The Dotcom Bubble Burst
In the second half of the 1990s, the commercialisation of the Internet excited and inspired many business ideas and hopes for the future of online commerce. More and more internet-based companies (‘dotcoms’) were launched and investors assumed that every company that operates online is going to one day become very profitable. Which unfortunately wasn’t the case – even businesses that were successful were extremely overvalued. As long as a company had the ‘.com’ suffix after its name, venture capitalists would recklessly invest in it, fully failing to consider traditional fundamentals. The bubble that formed was fuelled by overconfidence in the market, speculation, cheap money and easy capital.
On 10th March 2000, the NASDAQ index peaked at 5,048.62. Despite the market’s peak however, a few big high-tech companies, such as Dell and Cisco, placed huge sell orders on their stocks, which triggered panic selling among investors. The stock market lost 10% of its value, investment capital began to melt away, and many dotcom companies went out of business in the next few weeks. Within a few months, even internet companies that had reached market capitalisation in the hundreds of millions of dollars became worthless. By 2002, the Dotcom crash cost investors a whopping $5 trillion.
As long as a company had the ‘.com’ suffix after its name, venture capitalists would recklessly invest in it, fully failing to consider traditional fundamentals.
8. The 2008 Financial Crisis
This market crash needs no introduction - we all must remember how ten years ago Wall Street banks’ high-risk trading practices nearly resulted in a collapse of the US economy. Considered to be the worst economic disaster since the Great Depression, the 2008 global financial crisis was fed by deregulation in the financial industry which allowed banks to engage in hedge fund trading with derivatives. To support the profitable sale of these derivatives, banks then demanded more mortgages and created interest-only loans that subprime borrowers were able to afford. As the interest rates on these new mortgages reset, the Federal Reserve upped the fed funds rates. Supply outplaced demand and housing prices began to decrease, which made things difficult for homeowners who couldn’t meet their mortgage loan obligations, but also couldn’t sell their house. The derivatives plummeted in value and banks stopped lending to each other.
Lehman Brothers filed for bankruptcy on 15th September 2008. Merrill Lynch, AIG, HBOS, Royal Bank of Scotland, Bradford & Bingley, Fortis, Hypo Real Estate, and Alliance & Leicester which were all expected to follow however were saved by bailouts paid by national governments. Despite this, stock markets across the globe were falling.
And we all remember what followed… The bursting of the US housing bubble and Lehman Brothers’ collapse nearly crushed the world’s financial system and resulted in a damaged house market, business failures and a wounded global economy.
Don’t miss our articles on the impact of the Lehman Brothers’ collapse:
https://www.finance-monthly.com/2018/09/lehman-brothers-lessons-have-we-learned-anything/
9. The Flash Crash 2010
On 6th May 2010, the US stock market underwent a crash that lasted approximately 36 minutes, but managed to wipe billions of dollars off the share prices of big US companies. The decrease occurred at a speed never seen before, but ended up having a very minimal impact on the American economy.
With the opening of the market on 6th May 2010, there were general market concerns related to the Greek debt crisis and the UK general election. This led to the beginning of the flash crash at 2:30pm - Dow Jones had declined by more than 300 points, while the S&P 500 and NASDAQ composite were affected too. In the next five minutes, Dow Jones had dropped a further 600 points, reaching a loss of nearly 1000 points for the day. By 3:07pm things were looking better and the market had regained much of the decrease and only closed at 3% lower than it opened. The potential reasons behind the crash vary from ‘fat-fingered’ trading (a keyboard error in technical trading) to an illegal cyberattack. However, a joint report by the US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) stated that the extreme price movement could have been caused by the combination of prevailing market conditions and the large automated sell order.
As some securities lost 99% of their value in a few minutes, this was one of the most impressive stock market crashes in modern history.
10. 2015–16 Chinese Market Crash
After a few years of being viewed in an increasingly favourable light, China’s Stock Market burst on 12th June 2015 and fell again on 27th July and 24th August 2015. Despite the Chinese Government attempt to stabilise the market, additional drops occurred on 4th and 7th January and 14th June 2016. Chaotic panic selling in July 2015 wiped more than $3 trillion off the value of mainland shares in just three weeks, as fear of complete market seizure and systemic financial risks grew across the country.
Surprise devaluation of the Chinese yuan on 11th August and a weakening outlook for Chinese growth are believed to have been the causes for the crash that also put pressure on other emerging economies.
Sources: https://www.investopedia.com/features/crashes/crashes2.asp https://www.britannica.com/event/South-Sea-Bubble http://www.habsburger.net/en/chapter/crisis-highest-circles-economic-boom-and-stock-exchange-crash https://www.citeco.fr/10000-years-history-economics/industrial-revolutions/crash-of-the-vienna-stock-exchange-in-austria https://www.history.com/topics/great-depression/1929-stock-market-crash https://www.thirteen.org/wnet/newyork/ https://www.britannica.com/event/Asian-financial-crisis https://qz.com/1106440/black-monday-1987-the-stock-market-crash-that-was-so-bad-hospital-admissions-spiked/ https://www.investopedia.com/terms/d/dotcom-bubble.asp https://www.thebalance.com/what-caused-2008-global-financial-crisis-3306176 https://www.thestreet.com/markets/history-of-stock-market-crashes-14702941 https://www.sec.gov/news/studies/2010/marketevents-report.pdf https://www.economist.com/news/2015/08/24/the-causes-and-consequences-of-chinas-market-crash
With the 10th anniversary of the Lehman Brothers’ shocking and unprecedented bankruptcy this month, Katina Hristova looks back at the impact the collapse has had and the things that have changed over the last decade.
Saturday 15 September 2018 marked ten years since the US investment bank Lehman Brothers collapsed, sending shockwaves across the financial world, prompting a fall in the Dow Jones and FTSE 100 of 4% and sending global markets into meltdown. It still ranks as the largest bankruptcy in US history. Economists compare the stock market crash to the dotcom bubble and the shock of Black Friday 1987. The fall of Lehman Brothers was a pivotal moment in the global financial crisis that followed. And even though it’s been an entire decade since that dark day when it looked like the whole financial system was at risk, the aftershocks of the financial crisis of 2008 are still rumbling ten years later - economic activity in most of the 24 countries that ended up falling victim to banking crises has still not returned to trend. The 10th anniversary of the Wall Street titan’s collapse provides us with an opportunity to summarise the response to the crisis over the past decade and delve into what has changed and what still needs to.
As we all remember, Lehman Brothers’ fall triggered a broader run on the financial system, leading to a systematic crisis. A study from the Federal Reserve Bank of San Francisco has estimated that the average American will lose $70,000 in lifetime income due to the crisis. Christine Lagarde writes on the IMF blog that to this day, governments continue to ‘feel the pinch’, as public debt in advanced economies has risen by more than 30 percentage points of GDP – ‘partly due to economic weakness, partly due to efforts to stimulate the economy, and partly due to bailing out failing banks’.
Afraid of the increase in systemic risk, policymakers responded to the crisis through quantitative easing and lowering interest rates. On the one hand, quantitative easing’s impact has seen an increase in asset prices, which has ultimately resulted in the continuation of the old adage, the rich get richer and the poor get poorer. The result of Lehman’s shocking failure was the establishment of a pattern of bailouts for the wealthy propped up by austerity for the masses, leading to socio-economic upheavals on a scale not seen for decades. As Ghulam Sorwar, Professor in Finance at the University of Salford Business School points out, growth has been modest and salaries have not kept with inflation, so put simply, despite almost full employment, the majority of us, the ordinary people, are worse off ten years after the fall of Lehman Brothers.
Lowering interest rates on loans on the other hand meant that borrowing money became cheaper for both individuals and nations, with Argentina and Turkey’s struggles being the brightest examples of this move’s consequences. Turkey’s Lira has recently collapsed by almost 50%, which has resulted in currency outflow and a number of cancelled projects, whilst Argentina keeps returning for more and more loans from IMF.
Discussing the things that we still struggle with, Christine Lagarde continues: “Too many banks, especially in Europe, remain weak. Bank capital should probably go up further. 'Too-big-to-fail' remains a problem as banks grow in size and complexity. There has still not been enough progress on how to resolve failing banks, especially across borders. A lot of the murkier activities are moving toward the shadow banking sector. On top of this, continued financial innovation—including from high frequency trading and FinTech—adds to financial stability challenges. In addition, and perhaps most worryingly of all, policymakers are facing substantial pressure from industry to roll back post-crisis regulations.”
The Keynesian renaissance following that fateful September day, often credited for stabilising a fractured global economy on its knees, appears to have slowly ebbed away leaving a financial system that remains vulnerable: an entrenched battalion shoring up its position, waiting for the same directional waves of attack from a dormant enemy, all the while ignoring the movements on its flanks.
If you look more closely, the regulations that politicians and regulators have been working on since the crash are missing one important lesson that Lehman Brothers’ fall and the financial crisis should have taught us. Coming up with 50,000 new regulations to strengthen the financial services market and make banks safer is great, however, it seems that policymakers are still too consumed by the previous crash that they’re not doing anything to prepare for softening the blow of a potential new one. They have been spending a lot of time dealing with higher bank capital requirements instead of looking into protecting the financial services sector from the failure of an individual bank. Banks and businesses will always fail – this is how capitalism works and no one knows if there’ll come a time when we’ll manage to resolve this. Thus, we need to ensure that when another bank collapses, we’ll be more prepared for it. As Mark Littlewood, Director General of the Institute of Economic Affairs, suggests: “policymakers need to be putting in place a regulatory environment that means that when these inevitable bank failures occur, they can fail safely”.
In the future, we may witness the bankruptcy of another major financial institution, we may even witness another financial crisis – perhaps in a different form. However, we need to take as much as we can from Lehman Brothers’ collapse and not limit our actions to coming up with tens of thousands of new regulations targeted at the same problem. We shouldn’t allow for a single bank’s failure to lead us into another global crisis ever again.
Written by Andrew Boyle, CEO of LGB & Co
With global debt hitting another record high in the first quarter of 2018, some are sounding the alarm over the threat of a new financial crisis. The global economy has been growing for a prolonged period, so the argument goes, and it is now at the stage in the cycle at which something could go wrong. The latest figures from the Institute of International Finance (IIF) are undeniably eye-wateringly high. According to the IIF, the global debt mountain was $247 trillion (£191 trillion) in the first quarter of 2018. Meanwhile, the International Monetary Fund (IMF) has begun to warn that corporate and government debt is now higher than before 2008’s financial crisis at 225% of global GDP. The IMF also warned that governments in particular, and corporations, with elevated debt levels were “vulnerable to a sudden tightening of global financing conditions, which could disrupt market access and jeopardise economic activity.” But the current level of global debt may not be as destabilising as some fear. Taking into account its composition, we are probably better placed today to manage global debt than we were ten years ago.
Debt levels are high but have rebalanced
There are some differences between the 2008 financial crisis and now. The main one is debt which is now more evenly distributed. According to the IIF’s own figures, in the first quarter of 2018 household debt accounted for 19% ($46.5trillion) of global debt, corporate debt stood at 30% ($73.5 trillion), government debt at 27% ($66.5 trillion) and debts of financial institutions at 25% ($60 trillion) of the total figures.
Compare those figures with the same quarter a decade ago and they look like this: household debt 21% ($37 trillion), corporate debt 26% ($46 trillion), government debt 21% ($37 trillion) and financial institutions, 32% ($57 trillion).
Two things stand out. The first is that household debt has fallen a little in percentage terms, which suggests its current level is not excessive. The second is the increase in government debt and decrease in financial debt are almost the same. This is consistent with the objectives of the quantitative easing (QE) that we have seen since the financial crisis. QE involves financial institutions selling government and corporate bonds to central banks and on-lending the proceeds principally to companies.
Government debt can be good for economic growth
The debt to global GDP ratio has actually been falling for four consecutive quarters, according to the IIF. This is because global GDP has been picking up fairly robustly over the last year leading to incomes rising faster than debts. This should make the private sector debt burden easier to service, even if interest rates start to creep up.
While other factors are also at play, greater levels of public debt lead to private sector surpluses and stimulate economic activity. A simple way to look at this is that government expenditures include salaries and payments to contractors that are deposited into bank and savings accounts. Financial institutions then enable governments to balance their books by purchasing government bonds.
A substantial portion of a government’s deficit expenditure should be allocated to investment in infrastructure and innovation so that productivity gains will enable the additional debt burden to be serviced through rising tax contributions. Infrastructure investment and support for innovation are certainly high up on the UK government’s agenda. Of course, we will only know in hindsight if its allocation of resources to these areas has been adequate.
Corporate net debt ratios are stable
There is a fear that corporate debt is now so high that should interest rates rise suddenly, many companies would be unable to service the increased interest. Once again, the aggregate level of debt is not the only factor to consider.
In fact, many large corporates have huge stockpiles of cash sitting idle. US corporations alone are estimated to be sitting on around $2.1 trillion at present. While admittedly the majority of this cash stockpile is held by the US giants, corporates overall have borrowed fairly responsibly and have, in general, manageable maturity schedules. Corporate net debt levels are sitting around their 30-year average, so while the headline figures look alarming, the ability of most companies to cover their debts is reasonably robust.
Central bank policy will remain accommodative
Moreover, central banks have been at pains to point out that they are in no hurry to hike interest rates. Levels of government borrowing make them inclined to do so only if absolutely necessary.
When the Bank of England raised rates on 2nd August, its main concerns were the tightness of the labour market and firming of unit labour costs, and the impact that these factors might have on inflation. However, its Monetary Policy Committee concluded that any future increases in the Bank Rate were likely to be at a gradual pace and to a limited extent. Markets currently forecast that the Bank of England will only hike interest rates once next year and once again in 2020 taking the UK base rate to 1.25%. At this rate of increase it may not be until the 2030s that we reach the interest rate levels last seen in 2008.
In the US, while the Federal Reserve has already begun hiking interest rates and done so at a slightly faster pace, this has been justified by the fact that its economy is growing more quickly than the UK’s. It also still has more than $4 trillion of QE to unwind and, as was seen in February, any attempt to speed up the process up is likely to lead to a sell-off on Wall Street. So, the US Federal Reserve is likely to continue to tread carefully as will the Bank of England and the European Central Bank (ECB). Any rise in interest rates and any unwinding of QE will happen at a slow and gradual pace.
Borrowing in foreign currencies
Many countries have run into trouble by borrowing in foreign currencies. For example, Argentina has $4.1 billion in debt to pay this year and $13.3 billion in 2019, of which $3.4 billion and $5.9 billion are denominated in US Dollars. The recent collapse of the Peso and hiking of interest rates to 60% have made its position precarious.
Turkey too has seen a 40% plunge in the value of its currency, the lira, as well as high inflation. Turkey faces a series of problems, not least of which, around $179bn of Turkish external debt matures in the year to July 2019, equivalent to almost a quarter of its annual economic output. Most of the maturing debt — around $146 billion — is owed by the private sector, especially banks. With luck the knock-on effect of Turkey’s difficulties is likely to be minimal. While the collapse of the lira has an obvious and crippling impact on their ability to refinance that debt, no foreign financial institution has lent so much to Turkish companies that it is at risk of collapse, although some may take a significant hit.
The main concern is that the crises in Argentina and Turkey will spread to other countries and that the current strength of the US dollar puts at risk the $3.7 trillion of dollar denominated debt that has been borrowed by emerging market economies in the past ten years. But the current dollar strength will probably also hold back the US Federal Reserve from raising interest rates for fear of putting the whole of that debt at risk.
It is possible that significant currency movements will be triggered by political developments such as Brexit or international trade disputes. For the time being the pattern seems to be a sharp rhetoric from political leaders followed by compromise or a shift in position.
China
And then there is China. In 2007, China accounted for just 4% of global debt, but this had ballooned to 15% by 2016. When critics of global debt talk about their concerns about a looming crisis or fresh financial crash, a large part of that is bound up with concerns about China and it’s not hard to see why.
Corporate bank-borrowing has exploded since the global financial crisis. It is harder to understand where debt is being invested in China and there are many who are suspicious that much of this money has been wasted risking a destabilising financial crisis or long-term stagnation in the world’s second largest economy.
Debt in Chinese state-owned entities (such as banks) stands at 115% of GDP, but equally China is a huge creditor nation. Meanwhile, the pace at which debt is being accumulated in China has been falling for a number of years, so it is likely that the risk presented by debt in China is also falling.
Have the lessons been learnt?
Taking into account the composition of global debt, it does seem that the risks to the world’s financial system are less than implied by the absolute level of borrowing. The exposure to households, corporates and financial institutions is proportionately less than it was ten years ago. Debt service costs are low. Nevertheless, events in Argentina and Turkey highlight the need for all borrowers, whether governments or in the private sector, to match borrowing with the resources to pay.
The financial crisis in 2008 has cast a long shadow. There has been growing pressure on the government to increase accountability and governance in the financial services industry through legislation and regulatory reforms. One such reform that is set to take effect later this year and eventually apply to much of the industry within a year is the extension of the Senior Managers and Certification Regime (SM&CR), which seeks to improve the accountability and responsibility of senior personnel. This week Finance Monthly hears from Alexander Edwards, a Senior Associate at Rosling King LLP, who discusses the details of the new regime and explains what action management should take moving forward.
This extension of the certification regime is being overseen by the Parliamentary Commission for Banking Standards (PCBS), which was set up to improve accountability and standards in the industry.
When the certification regime was originally being considered, the commission’s recommendations ranged from general observations on standards – it suggested that firms need to take more responsibility for employees being fit and proper to ensure better standards of conduct at all levels, to the far more specific – notably recommending a new accountability framework for senior management.
As a result of the PCBS recommendations, Parliament voted through legislation in December 2013 which resulted in the Financial Conduct Authority (FCA) applying the SM&CR to the banking sector. Parliament subsequently voted through further alterations to the legislation in May 2016, requiring the FCA to extend the regime to all firms authorised by virtue of the Financial Services and Markets Act 2000 (FSMA). Similar measures have been adopted in other sectors as a way of building trust, such as the Financial Reporting Council that now oversees the appointments of directors at the big audit firms.
It is worth looking at the certification regime in greater detail and understanding what exactly the FCA has been saying about it to fully appreciate its implications. In its 2018/2019 business plan the FCA mentioned that the new rules, concerning the extension of the SM&CR to all FSMA firms in 2018/2019, were due to be published in the summer of this year.
In the FCA’s business plan, they highlighted that they were working on finalising the rules for the extension of the certification regime to all FSMA regulated firms, with a view to reflecting the FCA’s intention to tailor the regime to “reflect the different risks, impact and complexity of firms in a clear, simple and proportionate way.” Considering that the SM&CR is due to be extended to cover c.47,000 firms, that is no easy task.
There are three primary groups who will be regulated by the SM&CR: Solo-regulated firms, insurers and banks.
Solo-regulated firms
For solo-regulated firms (regulated by the FCA only) the SM&CR will replace the Approved Persons Regime. In July 2018, the FCA released feedback and near-final rules, along with a guide on the SM&CR for FCA solo-regulated firms. The aim appears to be, as it was from the beginning, to address and limit the lack of accountability of senior management which can subsequently drive poor conduct. The result: making senior management more responsible for their actions and conduct. The guide is designed to help firms which are moving across to the certification regime.
Insurers
For insurers the SM&CR will replace the Approved Persons Regime and the PRA's Senior Insurance Managers Regime. The Treasury has confirmed that the certification regime will start to apply to insurers on the 10th December 2018.
Banks
The SM&CR already applies to UK banks, building societies, credit unions, branches of foreign banks operating in the UK and the largest investment firms regulated by the PRA and the FCA.
So as we can see the certification regime has gone from covering banks, building societies, credit unions and PRA-designated investment firms, to covering all FCA solo-regulated firms.
It is worth noting that the extension of the certification regime will affect not only firms authorised and regulated by FSMA and the FCA but also EEA and third-country branches and insurers. Although the FCA has noted that the final rules in relation to the extension of the SM&CR are subject to change, particularly following any Handbook changes which follow the UK’s exit from the European Union.
To ensure that the new regime is proportionate and flexible enough to accommodate different business models, the FCA are introducing 3 different tiers of application:
Core Regime – this will apply to the majority of FCA solo-regulated firms;
Enhanced Regime – additional rules which will apply to c. 350 FCA solo-regulated firms, applying additional rules due to the size, complexity and potential impact on consumers of the firm;
Limited Scope Regime - applies to firms with a limited application of the approved persons regime e.g. limited permission consumer credit firms.
In response to the FCA’s consultation, respondents have requested further clarification in relation to the extension of the rules. Following receipt of responses, the FCA has confirmed that they will make some minor changes to the proposed rules. For example, they will lengthen the time period from 6 to 12 months for firms to implement the Enhanced Tier, once they meet the relevant criteria.
So what are the key conclusions firms should draw and actions they should take from the consultation?
Firstly, all firms which are regulated and authorised under FSMA and the FCA should be considering and reviewing the rules and functions of their personnel at this stage, to consider how the extension of the regime will affect them.
The date for implementation is set as 9 December 2019 (and 10 December 2018 for insurance firms), so firms should be looking at their own operations and consider transitional provisions at this early stage to ensure they are adequately prepared for the change. Particularly in the run up to Brexit, firms should also be re-reviewing their systems and operations to ensure that any changes to the Handbook are implemented as appropriate.
From a practical point of view, introducing the certification regime into firms in which it does not currently apply is likely to cross the borders of many departments, from Legal to Compliance to HR, so whilst December 2019 may seem far off now, experience has shown us that this will involve a broad spectrum of individuals and departments to successfully and smoothly transition to the SM&CR.
This month marks the tenth anniversary of the run on Northern Rock, leading to a more widespread financial crisis, with a number of banks bailed out by governments in the UK and around the world. A decade later, large established banks face new threats on several fronts.
As challenger banks and disruptive technology companies increasingly eat away at the services traditionally offered by the banks, the situation is exacerbated by the incoming regulatory changes of the Open Banking initiative. When the second Payment Services Directive (PSD2) comes into force in January 2018, banks will be required to open up their customer data to third parties. Customers will be able to directly compare the offering of their traditional bank with those of competitors.
Pini Yakuel, CEO of Optimove, which studies the science behind customer engagement, comments: “The past ten years have in some senses been defined by the aftermath of the financial crisis, but the next ten years will be defined by technology disruption that changes how banks interact with their customers forever.
“The disruption coming with the Open Banking initiative is huge for customer engagement. Customers will be able to compare the value that each financial services company offers them quickly and easily.
“We know already that eight out of ten millennials are happy to switch banks for better rewards[1]. The move to make the industry more transparent will allow individuals to compare these rewards like-for-like and switch to companies that provide them. Banks now have a real fight on their hands to retain a generation of smartphone-empowered, brand-agnostic consumers.
“Understanding behaviours, preferences and needs more clearly is key to developing the kind of emotionally intelligent communication with customers that makes them feel comfortable with their bank and helps them to make good financial decisions. Those banks who can offer something back at each stage of their relationship with each customer will set themselves apart under the intense scrutiny of Open Banking.
“To keep ahead of their competitors, they will need to tailor services to support customers more effectively, offering real value that appeals to each customer personally. Artificial Intelligence and automation tools which reveal what value looks like to each customer will be the secret weapon to help banks succeed in this environment.”
(Source: Optimove)
