Can Banks be rescued?

Banks' shares in a freefall
The government's plan to help banks sent banks' shares down by historic amount

Today was a day, which made records, but not pleasant ones. It made Friday's freefall of banks' shares to look like as if they were floating.

Royal Bank of Scotland (RBS) was the biggest loser today not just within the banking sector, but in whole FTSE 250. Its share price plunged by more than 66%!!! Bringing down its price level to the lowest ever of just 11.6p, making its market capitalisation to under £5bn! It was a company, which took over then Netherland's biggest bank, ABN Amro for a massive €71bn (just under £50bn at the exchange rate at the time of merger) in less than two years ago, October 2007.

In fact, its acquisition of ABN Amro is a huge source of its troubles, as it bought during the peak of stock market. Today, it faces £20bn of loss related to its acquisition of the Dutch Bank in addition to its write-downs of between £7bn and £8bn. It means it is to set a record in British Corporate History: the biggest loss ever. This potential total loss of £28bn is almost the double of the current record of £15bn held by Vodafone in 2006.

The government is also changing its preferance shares (with no voting rights, but with fixed percentage interest rate before anyone else gets paid) to ordinary shares (with voting rights, but with variable divident). It will bring the government's stake in the bank from 58% to 70%, and this time with voting rights! So there is no wonder, why investors dumped its stocks non-stop today. Its trading volume reached to a massive 744 million shares, the highest level ever seen as far as my data goes (the first available data being January 1st, 2003). I am sure the lift of ban on short-selling on last Friday helped it too. The ban was initially introduced by the Financial Services Authority (FSA), the UK watchdog of financial institutions, in September 18th, 2008 after a heavy loss of banks' shares. The next day, on Friday of September 19th, FTSE saw its biggest ever daily-gain in percentage term at the time of 8.8% (it was broken in November 28th, 2008, 9.84% rise).

Lloyds Banking Group saw its share price plunge by more than 33% on its first trading day. Lloyds Banking Group is the new bank, as a result of the merger between Lloyds TSB and HBOS. It is now the biggest high street bank in the UK with more than 3000 branches across the country. The UK governments has a stake of just over 43% in the new "super-bank".

Standard Charteded's share price dropped by 12.1%. Barclays share price slides down for the 5th day-in-a-row after gains of 8 consecutive-days. In percentage terms, it is down by more than 52% than last Tuesday, just before it started falling and still down by over 40% than its magnificient continuous rise of 8 days. HSBC, another bank refusing a state help, saw its shares down by 6.5% amid the rumour of it is running out of cash, and soon need to be rescued, although HSBC has not announced anything officially.

All of these huge drops come just after the second bail-out plans (worth £100bn) set by Mr Gordon Brown, the UK Prime Minister over the weekend while he was in Middle East on the talks of Gaza ceasefire-plan.

Today was the day, that British Bankings System came close a collapse once again after a turmoil in September and October. Some of the biggest names in the sector, HBOS and RBS came dangerously close to collapse in October before the first bail-out of £37bn by the UK government. Yet, most of us started believing that the banks are so huge now, that it is impossible for them to collapse till September 2007, when Northern Rock collapsed. It was the biggest bank to fail for 12 years, after Barings collapsed in 1995 due to massive loss of £800mn made by Nick Leeson, a rogue trader.

One then asks, how come the banks are so fragile? After all, they have been making record profits of billions of pounds, or even tens of billions of pounds just 2, 3 years ago. Where did all these profits go?

The banks are so vital to the functionality of the UK economy as a whole, that the government is determined not to let any of the big banks to fail. However, it seems, the damage is already done, the confidence in the banks are gone. At the same time, banks' confidence in the economy is gone, as a result they are so reluctant to lend money to even sound businesses. The government has been trying hard to revive those confidences ever since it nationalised Northern Rock in September 2007, but it seems its efforts to help the situation are sending "the economy is in trouble" and "the banks are in trouble" signals, just the opposite of what they want.

The government's fiscal effort has not been much better. Its cut of 2.5 percentage point in VAT for 13 months was a joke, more or less waste of money (gone tax revenue of £12.5bn), resource (physical and human costs related to the change of VAT) and time (all the time spent on changing VATs and recalculating). The monetary decision made by Bank of England, doesn't help the banks either. The low interest is just squeezing the margin for the banks and make it more difficult to make money and pay their debts for the banks.

This economic downturn might be worse than any of us imagined before. The results from the last quarter of 2008 are horrifying and far worse than many experts expected. The industrial output is down in both developed and developing economies by a huge amount, for example Taiwan's fell by more than 45% in the three months up to November 2008 compared to previous three months at annualised rate and South Korea's fell by 25%. The exports and imports in most countries are falling sharply, demands for many goods and services are collapsing around the world, with the exception of food and health care. Now deflation in rich economies are real and possible threat in 2009. The housing market is in a freefall, the average UK house price was down by 15.9% in 2008.

If any of the big banks fail in this time, the recession will be prolonged and even more severe. So the governments will try everything they can, in order to rescue the banks.

UPDATE (on 20th January 2009):
This morning FTSE and banks' shares saw a steep jump (but nowhere steep enough to compensate yesterday's loss) despite heavy losses in Asian markets (over 2% drops) and Asian banks' shares. However shares started falling again, hitting the bottom around 12PM and saw slight rise afterwards. From 3PM onwards, shares started sliding again, all banks' shares closing lower than yesterday's closing once again.

Here is the summary of day-performance:
FTSE down by 0.42%, closing at 4091.40
HSBC down by 3.19%, closing at 485.00p
RBS down by 11.21%, closing at 10.30
Lloyds down by 31.08%, closing at 44.80p
Standard Chartered down by 2.34%, closing at 689.50p
Barclays down by 17.16%, closing at 72.90p