The name “Bear Stearns” is enough to send a shudder down the spine of any investor who survived the financial crisis.
BEN MARLOW
6 JULY 2016 • 1:25PM
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| The name Bear Stearns sends a shudder down many investors' spines CREDIT: EPA |
The collapse of Lehman Brothers in September 2008 is generally regarded as the moment when the entire financial system almost came crashing down. But it is often forgotten that the glue that held it together had started to come unstuck more than a year earlier.
The first sign that things were unravelling was when American investment bank Bear Stearns prevented investors taking money out of two mortgage-related hedge funds in the summer of 2007. Eventually, both were liquidated.
At the time, the move seemed largely inconsequential to the wider world but within weeks BNP Paribas had taken similar action over three funds holding American mortgage-backed securities.
The events effectively meant the financial markets’ pricing system was broken and as a result markets went into freefall.
Share prices crashed and the interbank lending market dried up overnight, triggering widespread investor panic.
Within days, Northern Rock, the first UK lender to embrace mortgage securitisation, called the FSA to say it had a liquidity problem. The biggest financial crisis for nearly a century was under way.
Almost nine years since that fateful day, and the ghost of Bear Stearns is stalking the Square Mile again after the lockdown of three of the UK’s biggest property funds.
After the initial post-Brexit rout, which resulted in sterling and equities getting pummelled, markets looked to have finally calmed down with the FTSE 100 moving past its pre-Brexit level.
However, investors have been spooked once again after insurance giants Standard Life, Aviva and M&G, froze redemptions in their retail property funds.
While these funds are only suspended for an initial 28 days, a spate of so-called “gatings” in the space of less than 24 hours, has spread panic in the markets.
When an open-ended property fund such as this is forced to take such drastic action, it essentially means that the outflows are so large that they don’t have the liquidity to return cash to investors.
Naturally, this raises serious concerns about the resilience of the UK commercial property market and the possibility of a domino effect that would sweep through the sector.
Andrew Bailey, the deputy bank governor and next head of the FCA, has sought to calm nerves, describing Standard Life’s move as “sensible” because it prevents an exodus of money while the assets are revalued and buyers sought. Without that automatic trigger, investors at the front of the queue would be able to get their money back, while those at the back risked losing out.
However, markets are right to be concerned. At £4.4bn, M&G’s fund is the largest in the country, and at £2.9bn, Standard Life’s ranks third, while Aviva’s is no drop in the ocean at £1.9bn.
It is also is thought to be the first time UK property funds have halted trading since the financial crisis.
However, while there are clear parallels with the funds owned by Bear Stearns and BNP Paribas, the two situations are not the same. There is a big difference between investing in bricks and mortar and investing in derivatives based on securities based on sub-prime mortgages - for one thing the market for the former is much smaller than that for the latter and also less important to the wider financial industry.
The Bank of England still has some serious concerns about the commercial property market. Its Financial Policy Committee warned six months ago that prices were rising at a rapid pace while rental yields were falling. Yesterday in the Bank’s half-yearly financial stability report, commercial property was identified as one of five main risks that is starting to “crystallise” following the referendum.
The Bank is particularly concerned about the illiquid open-ended funds like M&G’s and Standard Life, which allow investors to demand their money back on assets that are hard to sell quickly. With around £35bn in these funds, Bailey admits this “liquidity mismatch” needed to be addressed.
The FPC’s bigger concern is that a sudden market reversal could hit the real economy. Many UK companies use commercial property as collateral to access finance, and the bank’s own analysis shows that 75pc of small businesses borrow from banks in this way.
Therefore in a downturn, companies may be unable either to refinance existing debt or to borrow to invest in new productive opportunities, which is when the wheels of the economy really start to grind to a halt.
Research suggests that every 10pc fall in UK commercial property prices leads to a 1pc decline in economy-wide investment.
It may not be a repeat of Bear Stearns but it may be a credit crunch on a smaller scale. Don’t don the tin hats just yet - but keep them close at hand.
http://www.telegraph.co.uk/business/2016/07/05/standard-lifes-halt-on-redemptions-echoes-the-start-of-the-finan/
