Another week, another big bank rip-off.
The Payment Protection Insurance (PPI) mis-selling scandal has only just come to a head. Banks are facing compensation claims of as much as £6bn from customers duped into buying insurance they didn't need.
And now big UK banks are all over the papers again this time for mis-selling another sort of insurance, this time to small businesses.
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Here's how it works
The latest ruse to siphon off client money
You're a small business and you take out a loan with a bank. And just like with PPI, the bank wants to hit you with some insurance too. Making interest on a loan isn't enough for these guys. They want to skim a few more quid out of customers.
With a small business, they can't sell insurance for critical illness, or to cover redundancy. So the banks had to be a little more imaginative.
The idea went a little like this: "Hey, that loan you're taking... Now you'd be a fool not to want to protect your business against interest rate moves. Look, we'll put together an interest rate swap contract. Basically, if rates move against you, this contract will pay out"
But what many business owners didn't realise was that if interest rates moved down (which of course they did) then they'd be on the hook for potentially hundreds and thousands of pounds.
And you can bet the banks were keen on shifting these policies. This from the Sunday Telegraph: "The case of Adcocks (a small electronics retailer) highlights just how much of an edge the banks had. Following 12 months of what Mr Adcock describes as "encouragement" from his local Barclays relationship manager, the company in February 2007 took out an interest rate hedge on its £970,000 of borrowings from the bank. Unbeknownst to Mr Adcock, on the day he signed the agreement, Barclays Capital, the bank's investment banking arm that structured the deal, is likely to have booked a profit of as much as £100,000 from the sale of the hedge."
These interest rates swaps have driven some businesses into administration. The banks have been siphoning cash straight out of business accounts as a result of adverse moves' in the interest swap.
Professor Michael Dempster of the University of Cambridge's Centre for Financial Research said: "I liken it to going to bet on a horse race having fixed the result. You're not guaranteed to win, but you have a heck of an edge on the punters."
All this could mean more huge claims against the banks. Prof Dempster said "I think this could be at least the same size as PPI."
So it's clearly another savage blow for the UK's retail banks. If you aren't already out of the banking sector, then these sorts of shenanigans ought to make you think twice about holding bank shares.
Especially when you consider the next insurance debacle.
There's a bigger and more dangerous scandal coming
Not content with selling loan insurance to hapless individuals and small businesses, the City wheeler-dealers created and sold an even more dangerous policy. This time they sold it to the pros.
I'm talking about the market for credit default swaps (CDSs). These are basically insurance policies covering against the risk of a nation going bust and not repaying its sovereign bonds.
But here's the thing. These policies aren't even real' insurance. Why? Because with a proper insurance policy, the guy writing it (ie, selling it) needs to hold reserves in case of any claims.
But these things were sold as credit derivatives that means the banks didn't have to put any capital aside should they have to meet a claim. So the big banks simply write a load of policies and rake in the cash.
Butwhat happens when someone wants to make a claim?
Well, we may be about to find out. Last Friday's decision by the Greek government to force bond holders to accept the terms of a debt restructuring will trigger CDSs.
Now the official figures say that the value of these contracts amount to $3.2bn. But in reality, the figure could be a lot higher. That's because this market isn't regulated and nobody really knows how many contracts have been created behind the scenes.
Make sure you're prepared for the coming inflation
As with the PPI and interest rate swap scandals, the CDS debacle is yet another example of how banks put together crazy deals to book handsome profits on day one.
Nobody ever seems to think about what's going to happen down the line.
But the real horror is that, as usual, it'll be the public that pays for the mess. It's all going on behind the scenes as we speak.
The European Central Bank is printing money to hand over to troubled banks. It's called the Long Term Refinancing Operation (LTRO). I gave you a quick rundown on how it works in a recent The Right Side article.
Though created out of thin air, ultimately this cash is backed by European citizens. It's a way of getting money out of them without them even realising its happening. It's nothing more than a vicious stealth tax. The value of their savings is diluted by the creation of new currency through LTRO.
This dilution ultimately leads to inflation (more money chasing the same number of goods). But the inflation could take years to work its way into the system. That's how stealthy it is. Nobody notices until it's too late.
My advice is to make sure the commodities side of your portfolio is well stocked. Prices are likely to be heading up as all this new money washes over the financial system.
In case you missed my commodities idea last Friday, you can read it here. And keep reading The Right Side for new ways to play this major theme in the coming weeks.
Why inflation must hit the UK and how to protect yourself
By the way, the threat of inflation isn't just a problem for the eurozone. Don't think for a moment we're safe from it here in the UK. I haven't seen anyone explain this threat better than David Stevenson, a colleague of mine. And hearing him rant about it on camera over the weekend, I'm with him all the way.
David's tirade is very short and to the point. But it makes the point brilliantly. And it superbly illustrates why UK investors should be concerned about the coming inflation right now and then shows some simple steps you can take to put yourself in a better position.
If you have just four spare minutes now, listen to David's warning here. That chart he shows is critical it will convince you to move, I'm sure of it.
This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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