With all the turmoil in the banking world, the disgrace of Iceland and a host of British savers getting a narrow escape*, I thought I would write a post about our often ignored building societies. After all, none of them have gone bust whilst all of the ones that the carpet baggers got their grubby hands have sunk like a stone. Just look at the casualty list of demutualised societies:

Halifax, Northern Rock, Bradford & Bingley, Alliance & Leicester, Birmingham Midshires… perhaps they should have remained mutual societies.

So why might building societies be safer than banks?

You have to look at why they demutualised in the first place. Northern Rock’s rapid expansion was only possible because it got a large portion of its funding from the money markets. This reliance on wholesale funding was ultimately the cause of it’s demise. Had it remained a building society it would not have been able to access this external capital, would not have been able to grow so aggressively and, I suggest, would not have gone belly up.

There are limits on how building societies can raise funds other than from individuals and on lending other than fully secured on residential property. At least 50% of the funds of a building society (or of the society’s group) must be raised in the form of shares held by individual members of the society. These rules leave no room for highly leveraged high risk growth strategies.

As at August 2008 there were 59 building societies in the UK with assets of £360bn, including mortgage assets of £250bn. Savings balances were £235bn. That seems pretty prudent to me.

The hunger for growth and expansion led Northern Rock to famously offer it’s 125% loan-to-value mortgages. This kind of irresponsible lending is not something you find in building societies. Building societies are primarily for the provision of (sensible) mortgage lending to members. They are not investment banks like Lehmans, JP Morgan, Goldman Sachs or any of the other irresponsible institutions that built their vast empires on massive leverage.

Now I hate to suggest that greedy executives drove societies to demutualise but… a study conducted in 2005 by Kent Business School showed that between 1993 and 2000 executive remuneration at demutualised societies increased by 293% compared to 65% at building societies.

Building societies also serve the wider interests of society in a way that banks just don’t. Not everything a building society does is driven by turning a profit – unlike banks. For example, if you struggle to get on the housing ladder and need a shared ownership mortgage where are you going to get one? Leeds building society, Kent & Reliance, Nationwide, (and Halifax but of course that’s a hangover from their mutual days). These are not the sort of institutions to take excessive risks for a bit of extra profit. They are cautious and, dare I say it, more caring than banks with a genuine concern for customers.

Having said all that, most of my personal money is not in building societies. I think that given the actions taken over the Northern Rock, Icesave, Bradford & Bingley episodes that if you are a UK resident with your money deposited in a UK bank then your savings are probably safe. I took my savings out of Icesave because I didn’t trust the Icelandic compensation scheme (phew!) but I have every confidence that my savings are safe where they are in Egg, Abbey, Northern Rock and Nationwide (the only building society on my list). Not only are they all covered by the UK Financial Services Compensation Scheme but the UK government has made it clear that they will not allow savers to lose their money.

* Readers from the Isle of Man have commented that there were no guarantees for them and another reader who had savings in the Guernsey branch but was not resident there says that he’s not sure if he is covered. Bank guarantees are not international.

I mentioned yesterday that people might now be looking at the creditworthiness of countries rather than the banks themselves.  This is after recent moves to bail out banks by several nations – most notably Ireland.  You see the funny thing is that in some cases the banks are now bigger than the gross domestic product (GDP) of their nations.  Here are a few examples:

Kaupthing Edge has total assets of €53bn – that’s 623% of Iceland’s GDP.

Landsbanki (IceSave) has €32bn – 374% of Iceland’s GDP.

They’re not the only banks in Iceland but between them represent around 1,000% of Iceland’s GDP.  With Glitnir having recently drained the Icelandic government’s coffers, would there be anything left to support other banks?  Of course it’s not quite that simple – if a bank goes bust all of it’s cash deposits don’t suddenly disappear.  On the other hand, this market is all about confidence – or rather a lack of it.

How about Ireland’s bank guarantee?

Bank of Ireland – €183bn – 102% of Ireland’s GDP.

Anglo Irish – €97bn – 54% of Ireland’s GDP.

Just two of the guaranteed banks have assets worth around 150% of GDP.  And let’s not forget that Ireland’s economy has been rather bloated recently due to an astonishing property boom that has now become a property crash.  The guarantee was a very shrewd move but essentially backed by thin air.

Now we turn to another bank popular with savers, ING.  It has assets of around €1,370bn which equated to 290% of the Netherlands GDP.

The UK has a number of huge banks.  RBS, HSBC, Barclays, HBOS, Lloyds TSB, Standard Chartered, Alliance & Leicester, Bradford & Bingley between them have assets of €6,900bn which represents 420% of GDP.

There is a nice list of these figures on the FT website here.

Banks declare each other likely to default due to their excessive leveraging then countries take on their bad debts to support them.  We are simply transferring all the bad debt to the countries instead.  Would I loan money to Iceland or Ireland?  Nope.

Just a quick word about things that were mentioned in the news recently:

1. The maximum protection under the Financial Services Compesation Scheme (FSCS) is still only £35,000.  There has been media coverage recently about raising it to £50,000 and this has in fact been scheduled to happen this year for some time.  The decision was made in the light of Northern Rock but the law has not yet been passed.

2. Around a third of Bradford & Bingley depositors had more than £35,000 on deposit and nobody lost a penny.

3. The Irish bank guarantee is telling – it covers only Irish banks.  And that doesn’t include banks who have a branch in Ireland, just those which are genuinely homegrown banks.  No taxpayers will want to prop up the banks of a foreign nation.  We are now in the realm of putting our money in banks based on their national origins and the willingness and financial ability of the government to intervene.

This is starting to sounds like something from a film.  Banks are falling like dominoes.  

1. We’ve all been worried about Kaupthing Edge and IceSave but here we are witnessing the nationalisation of Glitnir Bank. The Icelandic Government has taken a 75% stake in Glitnir for around £468 million after the company faced funding problems.  

Given that Iceland is a small nation – something like 300,000 people – whose banks rely on getting funding from international money markets, the news that the Icelandic Crown is down even further today will not help.  The remaining banks will effectively have to pay even more for their borrowing than before.  If Kaupthing Edge or IceSave need to borrow any money in the short term where will it come from?  I had some of my savings in IceSave but have transferred them to a UK bank. 

2. Bradford & Bingley nationalised.  The government provided a £14bn loan to protect customers’ deposits but the interest charged on this loan will have to be paid by other UK banks.  In other words the bank that goes bust leaves a mess that the more prudent banks have to pay for.  

3. The Netherlands, Belgium and Luxembourg have all chipped in to prop up Fortis with £8.9bn.  Smaller nations like Belgium and Iceland bailing out huge banks – I wonder how much money they have left to keep doing it if required.  Come to think of it, how will we keep doing it?  More borrowing.

Also in Europe:

Munich, Sep 29, 2008 – Hypo Real Estate Group has secured a major new credit facility which is designed to shield the company from the impact of the current malfunctioning of the international money markets.

Hypo Real Estate Group, Press release, 29.09.08

Did they say “current malfunctioning”?  I think they mean the current rationalisation of an industry that has been malfunctioning for at least a decade.  Also today, Hypo got rid of quite a few of its directors – strange if it’s just a malfunctioning market.  Anyway, the $50bn loan guarantee should keep afloat Germany’s second biggest commercial property lender.

4. Citigroup is rescuing Wachovia, the fourth largest US bank.  Citigroup is in no great shape itself but if it survives this era of financial meltdown it will be another banking giant.  This period of consolidation is likely to result in some truly enormous banks.

5. $620 billion pumped into the market from the Federal reserve but still markets around the world are today in turmoil.  The $700 billion rescue package or criminal misuse of public funds, depending on your opinion, has just been rejected although no doubt it will be back tomorrow in a different form.  Regardless of whatever measures are taken I am certain that more banks will fall.

So, are my savings safe?  They can be with a few different techniques.  Read my earlier posts How to get 100% protection on savings and Are my savings safe to see how.

The government has averted what would almost certainly have been another Northern Rock style run on the bank by taking action to nationalise B&B – the UK’s 8th largest bank – before the doors open on Monday.  It is said that depositors will not lose any money.  Apparently they are still looking for buyers for the various parts of the business although the bit that nobody wants will be kept in public ownership.  In other words the UK tax payer will keep hold of the self-certification and buy-to-let mortgage portfolios.

There are some really interesting features both of the events themselves and of the media coverage that it has so far received.

1. There seems to be anger at the nationalisation, not because taxpayers are once again taking on the undesirable parts of the business, but because shareholders are losing their money.

Shareholders who invested £400m in B&B during its rights issue last month are likely to be enraged at a nationalisation. Northern Rock was nationalised earlier this year and shareholders are likely to receive zero.

FT.com

Are they saying that B&B might not have gone bust?  You must be kidding.  Nobody was going to come in and buy them because events are moving too fast for appropriate due diligence to take place.  No bank can afford to take on the risk of buying a failing bank without proper research.  It would be irresponsible to their own shareholders.  And who is expected to compensate them anyway?  The same taxpayers who’ve just bought up the risky mortgage book that only exists because of the irresponsible lending activities that had previously been earning profits for the shareholders?  The FT continues:

However it is possible that the level of compensation paid to investors in this case could be higher, as unlike Northern Rock, B&B was not being supported by an emergency Bank of England loan.

Incredible.  Even more incredible as the FT also says this in the same article:

A further rating downgrade could also make it more difficult for B&B to access the Bank of England special liquidity scheme which some analysts estimate funds around 15 per cent of its loan book.

Don’t they read their own articles?

2. I’ve written about the Credit Default Swap (CDS) market before and it’s interesting to note what happened to B&B just prior to nationalisation.

 B&B, which was downgraded to one notch above junk status, saw its shares sink to an all time low of 20p on Friday. It was facing the possibility of another credit rating downgrade which would have made it almost impossible to raise money in the wholesale markets. Its credit default swaps have ballooned to 1500 – one of the highest of any bank in Europe – making it very difficult for the bank to fund itself in the wholesale markets.

FT.com

THE CDS market doesn’t always predict a bank’s demise but it is certainly a very good indicator of what the markets think about the potential for default.

3. Customers were voting with their feet at the first whiff of danger.

On Saturday B&B pulled in additional staff into its 200 branches to help deal with the larger than usual volumes of customers withdrawing money. There were queuing problems reported in just three branches – Doncaster, Finchley and Southport.

FT.com

Is it time to increase the Financial Services Compensation Scheme maximum to £50,000?  Or would people still panic and withdraw their money?  I wish I had some statistics to answer that question.

Meanwhile we await news of Wachovia and Fortis…

Could Bradford & Bingley be the next Northern Rock?  Their shares have fallen to an all-time low.  Apparently the government and financial regulators are monitoring their performance and Alistair Darling is being regularly updated on the situation by the Financial Services Authority.  This sounds like action will be taken if needed.

Market intervention is flavour of the month at the moment and the Bank of England is about to inject £40 billion into the money markets.  With banks reluctant to lend to each other, the Bank of England feels the need to prop up the liquidity in the market.  But then a couple of weeks ago they offered £25 billion and nobody wanted it. The fact is that the market does what it needs to do to reach equilibrium and no amount of intervention will succeed.  And I really don’t intend that as a gloomy prediction – I’m just saying that whatever the market decides (if that’s not too teleological a statement) is what will happen.