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.

The Greeks have joined the Irish in a bold promise to guarantee their banks.  If things go wrong for them then their taxpayers are in for a nasty shock, just like the Irish.  How long will it be before we have a truly two tier banking system where there are banks guaranteed by their home country and there are other banks where people feel it is unsafe to deposit their savings?  

We’ve already seen money flowing back into Northern Rock until they were forced to stop taking deposits due to their ‘unfair’ advantage of government backing.  The same thing may now be happening with Irish banks (although I don’t know how much I trust their guarantee).  Is there a point where the guarantee becomes worthless?  If the country itself doesn’t have the money in reserve, will anybody else loan it to them to make good on the guarantee?

The Germans are, rightly I think, against any plans for a european bailout:

The Greek move puts fresh pressure on Germany to back the mounting calls for an EU lifeboat fund to shore up Europe’s struggling banks, even though such a plans are anathema to Berlin. Chancellor Angela Merkel warned that there would be no “blank cheques” for those who get into trouble.

The Telegraph

Whatever the eventual outcome, the debate goes in on Europe and is likely to go on for some time:

Neelie Kroes, the EU competition commissioner, said that Ireland’s decision to act unilaterally — disregarding EU state aid rules — risked a descent into the beggar-thy-neighbour mayhem of the Great Depression.

“When Europe was confronted with a banking crisis in the 1930s, governments decided to go national and close their borders. Protectionism was not the solution at the time, as we very well know. Let us not make the same mistake twice,” she said. Brussels has already been overtaken by events.

David Owen, Europe economist at Dresdner Kleinwor, said Ireland had no choice, given the lighting pace of events on Monday. “Their banks were going down. No government can let that happen. They did exactly the right thing to ring fence this.”

How dare the British public seek to deposit funds with Northern Rock!  The safety of a nationalised bank appeals to a huge number of people and, 1 year after the run on the bank, we’ve had queues of people trying to put money back in.  The Moorgate branch in London was only seeing new customers by appointment even though they only had two products left to sell – their cash ISA and a branch saver (you have to go into a branch to do anything with your account!).  Customers who had made appointments the day before returned today to find that the well-priced bond they wanted had been withdrawn overnight.

So, why should we not seek the safety of Northern Rock?  Because the government guarantee gives it an advantage over other banks, making them more likely to lose savers’ deposits and therefore more likely to require a bail out themselves?  To be fair, they are committed to this course of action.  Under European competition laws, Northern Rock can not hold more than £17.6 billion in customer deposits – equivalent to 1.5 per cent of all savings held in British institutions.

Interestingly, National Savings, whose rates on most things are extremely poor anyway, cut it’s rates recently.  Making the safe havens less attractive?  Why do I get the feeling we’re being herded like little savings cattle?

UPDATE 2 – Iceland suspends trading in financial company shares

UPDATE – In the last few days I have moved my personal cash out of Icelandic banks.  That’s not a recommendation for you, just what I’m doing.  The article below was written about a week ago and this one ‘How to get 100% protection on savings’ was written yesterday.

Lots of people have been asking me recently if it is safe to save with Kaupthing Edge so I thought I’d do a quick post on that single topic.  First, I have no doubt that the reason you are all asking the question is because the interest rates paid by Kaupthing are excellent (at least at the time of writing) and you actively want to save with them – otherwise I would say just put your money in National Savings and Northern Rock (see my previous post Are your savings safe? to see why).

The most important thing to remember is that Kaupthing Edge are fully covered by the UK’s Financial Services Compensation Scheme. Under this, all your savings are guaranteed up to £35,000. However, if you put your account in joint names (assuming your partner won’t run off with your cash) then you are jointly covered for £70,000.  You’re not getting extra protection, just each person’s protection added together.  Also, remember that the compensation scheme is per institution, not per account.

So the fact is that you are covered up to £35,000 by the compensation scheme but what if lot’s of banks go bust – is there enough money in the scheme to protect everybody?  No, there isn’t enough right now but the government has pledged to loan the money to the scheme in order to meet any protection requirement.

So with all this protection in place you may wonder why the fuss?  The original worry over Kaupthing came about partly because earlier this year the credit rating agency Moody’s described the Icelandic banking system as ‘fragile’.  The problem is that Iceland’s banks were hit hard as the credit crunch arrived. Being based in a nation of just 300,000 people with a pretty small economy has led them to rely largely on the troubled money markets rather than customer deposits.  Kaupthing and Landsbanki both opened Internet banks to attract customer deposits and reduce their dependence on capital markets.  The price an institution needs to pay for money on the market is a pretty good way to guage how the city insiders view the risk it represents – there’s a really good article on it at Moneyweek.

IceSave, part of Icelandic bank Landsbanki, operates under the passport system to the Financial Services Compensation Scheme, where they run the equivalent of a UK branch from their home country.  This gives them European Economic Area authority rather than FSCS authority.  If the bank went bust you would have to make a claim to the Icelandic compensation scheme rather than the UK one.  Iceland pays a maximum compensation of around £16,300 (depending on exchange rate with the Euro) then any sum over this up to your £35,000 maximum would have to be claimed through the UK system. In other words, you’re still covered but it’s more complicated.  Oh, and the system’s never been tested.

The long and the short of it is that you will have to decide whether the additional interest earned at Kaupthing Edge is worth the risk.  Personally, I prefer safety.  If you want complete safety just go for National Savings or Northern rock.

With so much uncertainty and panic in the financial sector at the moment even those of us who don’t normally fret over such things are considering where to shelter our savings from the storm.  But let’s not forget that we are protected by the Financial Services Compensation Scheme in this country.

Visit their site for details but essentially if you have your savings in a UK bank or building society then the first £35,000 (set to rise to £50,000 sometime this year) is protected by the scheme.  If you have more than that in a single institution then it may be wise to spread your money across several banks so none holds more than £35,000.  Be aware that some different brand names are actually the same institution and you will only be covered once e.g. Abbey and Cahoot are the same and the whole of HBOS counts as one.  You can check this by looking at the FSA registration number on the website of your bank – if it’s the same on both sites then irrespective of the logo on the page it’s essentially one institution.

Foreign banks are different.  Make sure your bank is registered with the FSA and that it’s compensation scheme will cover you for the whole £35,000.  Of course compensation schemes are a last resort.  I’d rather my bank stayed solvent in the first place.

Do you have money in IceSave or Kaupthing Edge?

Icelandic banks were given a bit of a bashing by Moody’s this year who described them as fragile.  But then again what do the ratings agencies actually know?  Lehmans was rated A2 the day before it went bust! Financial instruments these days are so complicated and there are so many convoluted deals across the globe that even the bankers themselves have no clear idea what they are invested in and what risk they carry.  And that’s before you even mention frauds like Enron where you really have no idea of the risk.

Do you have money in Egg?

They are owned by Citigroup (they bought the poorly performing Egg from Prudential for around £575 million in 2007) who have been downgraded and are currently listed on Fitch ratings system as a negative outlook.  Should you worry more about that than the Icelandic banks?

Northern Rock – a nationalised bank

A year after the run on the bank it seems odd to say it but if any bank is safe it has to be Northern Rock.  We’ve already bailed it out at a cost of billions so the government just could not let it go under now and all deposits are 100% guaranteed.

National Savings – the original nationalised bank!

We tend to forget about boring old National Savings but your money is certainly safe there too.  The ISA rate looks pretty poor (at time of writing) but the index linked savings might be worth a look.

Legendary stupidity from an ailing government trying to buy safe passage through the next election:

Homebuyers will not have to pay stamp duty on properties costing £175,000 or less for the next 12 months.

You cannot stop the market from finding its own level. This measure will at best delay the inevitable and at worst cost the Treasury £600m in tax revenue without significantly impacting the housing crash. The measures don’t stop there though – there’s more stupidity to come:

* “Free” five year loans of up to 30% of a property’s value for first time buyers of new homes in England

* Extension of powers for councils and housing associations to be able to pay off debt for homeowners who can no longer afford mortgage payments and then charge rent.

* Shortening from 39 weeks to 13 weeks the period before Income Support for Mortgage Interest is paid

* Bringing forward spending from future years to encourage more social housing to be built

The funding for these measures, which unlike the stamp duty move will only apply in England, has been previously allocated and brought forward, the Treasury said.

BBC NEWS | Politics | Stamp duty axed below £175,000.

So this funding is just being ‘brought forward’ then? Does that mean the government was planning to introduce the 13 week period for Income Support anyway? I don’t believe it. The entire nation is borrowing from the future to save the skin of Gordon Brown.

Recessions are not pleasant for most of us but they are necessary to correct the market after a period of runaway growth.  Mr Brown’s protestations of unique circumstances not enountered for generations are ridiculous. We regularly have boom and bust in pretty much every market.

The government recently added nearly £100bn to the national debt with the Northern Rock fiasco – that’s around £3,000 for every household in the land. In 2007 the national debt was estimated at 43% of DGP (Source: CIA World Factbook) which ranks us 50th worst in the world. However there have been others who argue that much of our debt is disguised:

The respected Centre for Policy Studies think tank says the official Treasury figure of £487 billion wrongly excludes the cost of public sector pensions liabilities, the hidden costs of Labour’s flagship Private Finance Initiative contracts and debts incurred by Network Rail.

When these are taken into account the total is £1,340 billion, which is 103.5 per cent of GDP

Daily Mail | 26 November 2006

So while Gordon and his buddies go about freely spending our money let’s not forget who will pay the price in years to come.