City Diaries: 7 August

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Banking results have dominated the news this week. Our diarists discuss <a class="inlineText" href="#laura">those results</a> and the continued media interest in bonuses. Anthony believes it would irresponsible for managers <a class="inlineText" href="#anthony">not to pay</a> the going rate. Stephen <a class="inlineText" href="#stephen">takes a different</a> view.

These diaries are written by people who work in finance and have had a front row seat as their industry goes through the biggest changes in decades.

They give us regular insiders' updates on the mood in the City of London and the dramatic changes in the world of finance.

ANTHONY

Anthony, (not his real name), works for an investment bank in the City.

Champagne corks in Canary Wharf have not been popping

The press are back into "bash a banker" mode. As usual, they are getting hung up on bankers' bonuses.

The message is that the banks are making hay while the rest of the economy suffers. It makes good copy and reinforces the public's indignation at the insensitivity of the banking industry towards the economic plight we are in.

For me, and many of my colleagues, it's annoying because these payouts are reserved for a small fraction of the investment banking community. If you look round the bars in Canary Wharf and in the City, you will not see the champagne corks popping.

Unless we can get an international consensus on bonuses then these stories will continue. Restricting them only in London will undermine this city as the world's leading financial centre and damage the UK economy. Managers of banks would be irresponsible not to pay the going rate for the best talent.

The losses at Northern Rock and Lloyds TSB... show the true picture of the state of the banking industry

The profits of Barclays and HSBC were distorted by the performance of the investment banking divisions of these banks which accounted for a third of Barclays' profits and three quarters of HSBC. These profits are very volatile and can disappear very quickly.

Barclays and HSBC each made £3bn over six months. That sounds like lot. But as a percentage of the total invested it is not even a reasonable rate of return. Barclays needs to make about £10bn in a full year to create an acceptable return on capital invested.

The real story is the losses at Northern Rock and Lloyds TSB in the retail and commercial lending sectors. These show the true picture of the state of the banking industry as they are not so influenced by the performance of investment banking.

Northern Rock's bad loans have tripled in six months. Look again at Barclays and HSBC. Their bad debt charges have increased by 86% to £4.5bn for Barclays and $13.9bn for HSBC. Suddenly the profits don't seem so good after all.

There is no sign that bad debts will stop being a problem in 2010. And, although the housing market is up slightly, there is a growing feeling in the City that prices will start falling again until the 2010 election.

It will also be harder for the banks to lend more because the Financial Services Authority (FSA) has increased minimum capital requirements by around a quarter. This means that the banks have to put more money under the mattress rather than lending it out small businesses.

They are also forced to hold more of their assets in short term blue chip securities such as government bonds in order to deal with tighter liquidity rules. So cash is being tied up in government bonds rather than being lent to small businesses.

These are rules set by the government through the FSA which discourage the banks from lending.

So if I am right, why is the stock market rallying? It's because we are over the worst and prices had fallen too far but watch out for the second V of the "W" recession and another correction in October.

LAURA

Laura (not her real name) works for a commercial bank in London.

Losses at nationalised bank Northern Rock have grown by 24%

With all the noise about Northern Rock and Lloyds (the 'nationalised' banks) faring so much worse than the non-nationalised HSBC and Barclays, people have failed to notice something important.

It's the banks' investment divisions that have made much of this profit.

Some of the big profits have resulted from 'taxpayer' money, or the cash being used to bail out institutions by shareholders and pension funds.

Also, the fact that some banks have disappeared or been taken over means there is less competition, leaving the remaining banks to pick up even bigger slices of the profit pie.

When the economy does correct itself these investment arms will have fewer large capital raising schemes to underwrite and make profits from, so it may be that their profits fall back from their current position slightly.

To get a truer reflection of the UK economy, it is more important to look at the retail and commercial banking results - where the picture is not so rosy.

Behind every £1 of commercial debt that is written off is a failed employer and that means lost jobs.

Most of the money that has been written off has yet to be fully realised. These are the debts which the banks are going through the motions of trying to collect, but all parties involved know that the process is ultimately futile. The real loss of livelihoods and jobs is often therefore yet to materialise.

Small commercial business owners are still holding out for rates of 2%, and then wondering why banks aren't falling over themselves to lend

In the same way, behind every £1 of retail or personal debt that has been written off, is an individual or family that is potentially being made bankrupt, perhaps losing their home.

The cycle, which has yet to play out in UK Plc, sees commercial write offs self perpetuate into another personal debt that has to be written off as that person loses their job. This then dumps another under-priced home onto the market, undermining housing market recovery next year.

This is exactly why several people, many of my colleagues included, expect a W-shaped recovery. In other words we are currently experiencing the "dead cat bounce" phase, exacerbated by the summer silly season in the news.

Many of us are still scratching our heads as to when the end will be.

We have money to lend, but getting credit approval is virtually impossible.

As with any business, the only way to cover losses is to make more profit - and that means trading your way through a downturn.

In our case though, trading through means lending to new customers who we have no track record with - something that requires credit confidence.

Food for thought: the largest companies are happily paying 5% over base rate for their new loans as they realise they are lucky to get big chunks of cash from a bank at the moment.

Small commercial business owners are still holding out for rates of 2%, and then wondering why banks aren't falling over themselves to lend.

STEPHEN

Stephen (not his real name) has worked in the City of London for over a decade.

The basic beliefs that our generation held about money have been comprehensively demolished since 2007.

Generation Bubble has now learned that tearaway stock and housing booms always end with the "Winner's Curse" - especially when the notion that there is a bubble seems inconceivable. No longer are eternally rising house and share prices taken for granted as a basic human right.

One thing remains - that the workings of markets are as confusing to the average person as ever.

Yes, you read that correctly: as an insider, I think it is a disgrace that bailed out institutions - that would not exist were it not for the bailouts - are making such payments

Against a miserable economic backdrop, share prices have risen dramatically since March, a move almost unprecedented in the last 100 years.

So how can the markets be thriving?

And how can the banks that survived the crash without being nationalised, such as Barclays, HSBC and Goldman Sachs, be reporting such enormous profits?

The market surely knows about the Great Mortgage Famine. It knows too about this dilemma: that if we bring back "2007 levels" of lending, we're just heading back to what caused the problem in the first place - but if we don't, we have no other ideas for where "economic growth" will come from.

And despite the recent chatter over City bonuses courtesy of the public purse, there is not enough in this pool of ill-gotten wealth to lift house prices across the nation.

Yes, you read that correctly: as an insider, I think it is a disgrace that bailed out institutions - that would not exist were it not for the bailouts - are making such payments. It is simply not right that my industry can hold the entire economy hostage and then reap such brazen rewards.

It's true that it was only a handful of people that caused the problem. But the nature of working at a firm is that you share the risk of everyone you work with.

Europe is set for a credit card crisis, warns Stephen

And then there's the impending European credit card crisis. The IMF predicts this will be at least as bad as in the USA and worst of all in the UK. In the US something like 15% of credit card balances will not be repaid.

With the talk that commercial property is "the next shoe to drop" and that hundreds of thousands of British mortgages are in arrears and soon to default, we have an almost perfect storm of economic news.

So what are the markets celebrating?

There are various theories. On the one hand, computerised or "algorithmic" trading now dominates the exchanges. These machines are designed to exploit so-called "market inefficiencies" at millisecond timescales, but at the larger level these machines tend to amplify arbitrary trends.

Another theory is that the market is looking far ahead and seeing better times, which are yet to filter through in earnings reports and not just at the surviving banks. The negatives are all known and understood and so things can only get better

Or it could be simply that the central banks of the world have been engaging in "quantitative easing" - shorthand for giving money away.

Central banks around the world are pre-announcing which securities they will buy, and when. Dealers in these instruments have been loading up in advance in order to offload them at inflated prices when the central banks start buying.

Until the risk-taking activities of our banks are disentangled from the basic financial plumbing of our economy, I will continue my lament.

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