Rather than have separate items on investments and the economy this month we concentrate on providing a timeline summary of the exceptional events over the last few weeks before making a final commentary.

TIMELINE SUMMARY
7 September 08
US mortgage giants Freddie Mac and Fannie Mae taken into public ownership.
The US government announced the biggest financial bailout in the country's history (to date) as it took troubled mortgage giants Freddie Mac and Fannie Mae into temporary public ownership to save them from collapse.

The US treasury secretary, Henry Paulson, said the Federal Housing Finance Agency, hitherto the two companies' regulator, would henceforth run the companies in a state of "conservatorship" and the two chief executives would be replaced by new men.

It was the biggest corporate bail-out in history, worth £2.7tn, which is more than half the value of outstanding mortgages in the US.

15 September 08
Bank of America buys Merrill Lynch
Merrill Lynch is to be sold to Bank of America after writing down more than £22bn of assets in the past year. The deal was carried out in a $50 billion all-stock transaction

Under terms of the transaction, Bank of America would exchange .8595 shares of Bank of America common stock for each Merrill Lynch common share. The price is 1.8 times stated tangible book value.

16 September 08
Lehman Brothers collapse
Lehman Brothers Holdings Incorporated filed for Chapter 11 bankruptcy protection in the US, but none of Lehman´s other US subsidiaries or affiliates were included in the filing. This was to make it easier to sell off some of those companies, e.g. its investment management arm, as the group's business is wound up.

Over this side of the Atlantic, Lehman Brothers UK trading company was placed into administration. The administrator, PriceWaterhouseCoopers, has also been appointed as joint administrator of Lehman Brothers International Europe.

Lehman Brothers was an investment bank rather than a commercial bank, so there was been no queue of worried retail depositors, one of the many reasons why the US Treasury was prepared to see the bank fail rather than offer any guarantees.

However, Lehman was the fourth largest investment bank, so its links within the financial system were – and still are – very significant.

Some analysts commentated that the worst of the global banking crisis engulfing stock markets had come to an end following Lehman Brothers’ bankruptcy!!!!

AIG to lend itself $20bn
According to US press reports, American International Group stated it would borrow $20bn from its subsidies to bolster its capital.

The New York Times reported that a deal had been made between New York State regulators and the insurance giant to allow AIG to access $20bn of assets to use as collateral for a loan.

AIG shares plummeted more than 60 percent on the New York Stock Exchange the previous day amidst fears that it would be the next company to fall.

New York State Governor David Paterson reiterated the state’s support of the firm and declared AIG “financially sound”.

FTSE 100 falls through 5,000 floor
The FTSE 100 went below the 5000 mark for the first time since June 2005 as the Lehman-led financial crisis continued to hit markets.

Treasury Committee outlines financial stability proposals
The Treasury Committee called for a Financial Stability Committee to be established in order to control the Bank of England’s financial stability functions.

In its report, Banking Reform, the Committee said that this should be given comparable status and composition to the Monetary Policy Committee.

The report also called for heightened supervision to be considered a separate entity, segmented from normal supervision and the Special Resolution Regime.

The Committee said the FSA should be granted the sole responsibility for the making a firm subject to the Special Resolution Regime, but that the BoE should have the power to recommend a firm.

UK Inflation hits 4.7% as Govt target disappears for the foreseeable future
Bank of England governor Mervyn King had to write to the Chancellor yet again after inflation moved further away from the Government’s 2% target for August.

Consumer Price Index (CPI) annual inflation rose to 4.7% the previous month from 4.4% in July, the Office for National Statistics (ONS) said, as rises in gas and electricity bills took effect.

However, retail prices index (RPI) inflation fell to 4.8% per cent in August, down from 5% in July.

RPIX inflation – the all items RPI excluding mortgage interest payments – was 5.2% in August, down from 5.3% in July.

17 September 08
US government steps in to save AIG
Troubled insurer AIG was thrown a lifeline overnight as the US Federal Reserve announced an $85bn loan to save the business from bankruptcy.

The terms of the loan saw the public get an 80 per cent stake in the firm which has a trillion dollars in assets.

The insurer had seen its share price smashed over the previous two days amid fears it was to follow Lehman Brothers as the next company to fail.

The general consensus was that the Fed stepped in on AIG’s behalf - having refused to bail Lehman Brothers out earlier in the week - because the impact on world markets would have been far greater.

LIBOR at seven-year high
London Interbank Offered Rates reached a seven-year high in the wake of market turmoil over the previous 36 hours.

The overnight Libor rate in U.S. dollars soared 3.33 percentage points to 6.44 per cent on 17th September, its biggest jump for at least seven years, according to the British Bankers' Association.

The British Bankers Association said helpfully: “The LIBOR overnight rate recognises that, in the current uncertain market conditions, banks are looking to their own liquidity as the priority."

18 September 08
UK Government Bans Short Selling Bank Shares
Gordon Brown, announced a radical move in London on Thursday to ban the 'City's controversial tactic of 'naked' short selling shares on banks and financial institutions.

This is where traders bet on the stock price to fall, without first borrowing the shares or ensuring that the shares can be borrowed, as is done in a conventional short sale.

The move by Brown was an attempt to stop the credit-crunch fall out from haemorrhaging any further by adding a temporary regulatory barrier.

Lloyds unveil £12.2bn HBOS takeover
Lloyds TSB revealed the details of its £12.2bn takeover of Britain’s largest mortgage and savings bank HBOS.

Under the original terms of the deal, HBOS shareholders would receive 0.83 Lloyds TSB shares for every one HBOS share. Existing Lloyds stockholders would own approximately 56% of the enlarged group. This deal would subsequently be subject to re-negotiation following the Government’s bail out to the major banks in October.

The offer valued HBOS at £12.2bn, based on Lloyds’ 279.75p the previous day.

The FSA described the acquisition as a "welcome move" and a timely boost to the market.

"The FSA is satisfied that HBOS is a well-capitalised bank that continues to fund its business in a satisfactory way," its statement read.

19 September 08
US £700 billion bail out package announced for debate
An ‘exciting’ week culminated with a market bounce following the announcement by the US Treasury that it intended to spend $700 billion buying up ‘toxic’ bank assets in order to allow world financial markets to return to some kind of normality. The question remained, however, what will ‘normal’ look like following this crisis, and will those who claim that it’s different this time and things will never be the same again be proved right?

The rescue plan was debated by US Congress and originally rejected. Following much debate causing extreme angst and volatility to worldwide markets, the rescue plan was finally approved early in October.

23 September 08
Nomura to buy Lehman Bros UK and Europe
PricewaterhouseCoopers confirmed that Nomura was to acquire the UK and European investment banking and equities businesses of Lehman Brothers.

Commenting on the sale to the Asia-based investment bank, PricewaterhouseCoopers said that the deal was conditional on a number of issues but meant the continuing employment of around 2,500 Lehman’s staff.

29 September 08
CBI warns extra 12,000 jobs could go by Christmas
It was revealed by the CBI that financial services firms are expecting massive job losses in the sector before the end of 2008, according to research.

The CBI’s latest survey of the financial services found firms were at their least optimistic since the survey began almost 20 years ago.

The survey of trends in the sector, conducted by PricewaterhouseCoopers, indicated around 12,000 jobs are expected to be lost in the final quarter of 2008.

Bradford & Bingley nationalised
The Government nationalised the UK's eighth-largest bank Bradford & Bingley, with Santander taking on the beleaguered lender's savings business.

After a tense weekend of negotiation between the Treasury, FSA and the Bank of England, the Government unveiled plans to assume B&B's £41bn mortgage book, with a quick disposal of its £20bn savings operations and branches to Abbey and Alliance & Leicester owner Santander.

The Spanish banking giant paid £612m for B&B’s savings division, which includes 197 retail branches. It now has a combined 10% market share of UK retail deposits – under its three local brands.

Santander said the Bradford & Bingley name will be retained.

30 September 08
Libor rates see record rise
Inter-bank lending rates hit their highest point for more than seven years at the end of last month despite intervention from central banks.

Overnight Libor for dollar borrowing hit 6.87% as the continuing market turmoil made banks wary of lending to each other.

Libor reached its highest rate since early 2001, and saw its biggest daily rise on record.

7 October 08
Russia trading suspended after dramatic losses
Trading on Russia’s two leading stock exchanges resumed after both were forced to shut for several hours.

The RTS and Micex both climbed since the re-start following the postponement, which was sparked by dramatic 20% losses in value on Monday. Since May, the RTS index had dropped more than 60%.

The volatility prompted Russian President Dmitry Medvedev to call for urgent action to deal with the global financial crisis.

He called for “new solutions” to the problems.

UK savers hit as Iceland nationalised Landsbanki
Iceland’s government nationalised the country’s second largest bank, Landsbanki, also a major provider of savings products in the UK.

Earlier on 7 October, the Icelandic Financial Supervisory Authority (IFSA) took over the bank, having previously taken control of Glitnir the previous week.

Landsbanki owns the Icesave internet bank, which provided savings accounts and ISAs to UK consumers. Customers became unable to use their accounts prompting a call for intervention from Gordon Brown who tried to gain access to funds using anti-terrorist legislation.

The biggest problem with the collapse of the Icelandic Bank for the UK was that there were not just millions of pounds of private retail investors funds held but also large sums of taxpayers’ money deposited by local authorities.

Iceland’s government gave savers a 100% savings guarantee, but said that £4.5bn worth of investments in 300,000 UK accounts would not be covered by the scheme.

8 October 08
£50bn Govt rescue package unveiled plus £200bn liquidity
The Government unveiled details of a £50bn rescue package that will use taxpayer's money to take equity stakes in eight major UK banks.

The deal is in addition to £200bn of liquidity that will be made available by the Bank of England for short-term borrowing.

In a further move, the Government is providing temporary guarantees for money that banks borrow from each other in the wholesale markets, with take up expected to be an additional £250bn.

The Government will get preference shares in exchange for the funding it provides.

The banks concerned committed to collectively raising capital by £25bn either through conventional fund-raising or in exchange for the Government taking preference shares in the bank.

After this initial capital raising, the Government says it stood ready to provide a further £25bn for institutions at their request.

The Government will also provide a guarantee on the money that banks borrow from each other for a fee in a bid to restore confidence in the wholesale markets.

BoE makes emergency 0.5% interest rate cut
The Bank of England made the shock move to slash interest rates a day early by 0.5% to 4.5%.

In a coordinated effort to revive the ailing global economy, the BoE joined the Federal Reserve, European Central Bank, Bank of Canada, Bank of Sweden and the Swiss National Bank in taking emergency interest rate action.

"Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets," the joint central bank statement reads.

Worst financial crisis since 1930s - IMF
The global economy is in the midst of the most dangerous financial shock since the 1930s, the IMF warned.

In its latest World Economic Outlook report, the IMF calls for strong and coordinated actions to avoid a “worse-case scenario”.

The IMF expects growth in developed countries to be close to zero at least until the middle of 2009, while growth in emerging economies will slow to substantially lower rates than in recent times.

It said: “It is too late to avoid a slowdown, but strong and coordinated policies can avoid even worse scenarios.”

9 October 08
Iceland suspends share trading
The Icelandic Government suspended all share trading as the financial crisis continued to threaten the country with bankruptcy.

The Government took the decision to close the OMC Nordic Exchange Iceland until Monday.

Following the collapse of the country’s three largest banks, Kaupthing, Glitnit and Landsbanki, share prices plummeted in unique market conditions.

Icelandic authorities worried that panic in the banking sector might cause the country’s stock market to collapse, causing further turmoil in the tiny nation.

13 October 08
UK banks receive £37bn bail-out
The government confirmed it was to pump billions of pounds of taxpayers money into three UK banks in one of the UK's biggest nationalisations.

Royal Bank of Scotland (RBS), Lloyds TSB and HBOS will have a total of £37bn injected into them.

In return for the investment, the government will get a say in how the banks are run, including controls over the bonuses paid to management.

Commentators said that banks faced "absolute humiliation".

Some financial experts however, were critical of the government's strategy stating that the plan ignored shareholders' interests, and said it would ruin the City of London's position in world banking.

Under the plan RBS is to raise £20bn with a further £17bn to be put into HBOS and Lloyds TSB. Barclays intends to raise £6.5bn without government help.

As part of the banks' announcements there are to be serious management changes:
* RBS chief executive Fred Goodwin will quit with immediate effect without a severance pay-off. He will be replaced by British Land boss Stephen Hester. RBS chairman Tom McKillop will retire.
* Lloyds and HBOS said they had renegotiated their merger, reducing the number of Lloyds TSB shares that HBOS shareholders will receive.
* HBOS chief executive Andy Hornby and chairman Lord Dennis Stevenson said they would stand down from their posts after the merger with Lloyds TSB was complete. Neither will take any extra payments when they leave.

RBS and Lloyds TSB/HBOS will return mortgage and small-business lending to 2007 levels, which is much more than they are currently lending.

14 October 08
Consumer inflation reaches 5.2%
Falling oil prices should soon offer consumers some respite UK inflation hit 5.2% in September with energy bills behind much of the rise, official figures have shown.

Analysts expect this to mark a peak, with inflation tipped to slow as a result of lower oil prices and reduced demand in a slowing economy.

September's Retail Prices Index (RPI) figure - used to work out benefits and state pensions for the coming year - reached 5% from 4.8% a month earlier.

However, despite the gloomy inflationary news, the FTSE 1000 index rose further to about 4,500 following gains made on Monday, much as a result of renewed optimism following the implementation of a government rescue plan for British banks


COMMENT
Following a turbulent few months, the question many are asking at the moment is “how on earth did we all get into this mess?”

In simple terms, many banks borrowed large sums of money to invest in vehicles which supported US mortgage lenders in what we now know as the sub prime market i.e. those borrowers who ordinarily couldn’t afford mortgages unless on special deals. In the last year or two, a large number of these borrowers failed to repay their mortgages and the value of the vehicles supporting them as a result became worthless or at best, extremely difficult to value.

This left the investment banks with huge holes in their balance sheets looking for supporters to bail them out. In the case of Lehman in the US, the time had run out for them to find a rescue package. This also illustrates that whilst other banks were interested in buying the business, they would only do so if the liabilities were limited by the US government underwriting the loans.

So how was this allowed to happen in the first place with banks able to expose themselves in a way that was not supported by the cash in their businesses? Huge leveraged positions using special investment vehicles put the system in this position. Hopefully regulatory authorities will want to ensure this cannot happen again and will, once the system has stabilised, set a new regime to monitor and regulate this area.

There is still great uncertainty about the amount of liabilities in the market and it is this which is making banks reluctant to lend to each other and hence the difficulty in finding credit. This ultimately leads to a shortage of funding in the retail mortgage market and is the reason why loans remain expensive compared to the underlying interest rate.

At the moment, it is hoped that the domino effect of collapse will stop with governments such as that of the UK developing rescue plans to bail out banks, and provide capital in order that they can start lending in the markets to businesses individuals and even each other!

Certainly the equity markets have calmed a little after the turmoil of last week which saw the FTSE 100 move well below the 4,000 mark

At the moment, many may feel that the banking system and financial companies are not perhaps the place to invest although situations like this will inevitably create some great opportunities for well placed managers and investors to buy shares in sound businesses cheaply!

October 2008, taken from our CPD - Monthly notes and assessments.