Bad news from the banks, so why are shares soaring?

Why did share prices take off yesterday after investment banks raised even more capital to prop up their injured balance sheets? Well, it’s the usual triumph of hope over experience, says John Stepek.

Switzerland's biggest bank, UBS, announced its sub-prime-related losses had doubled to $37bn yesterday, sending it into a quarterly loss for the second quarter in a row.

It has raised another $15bn or so in a rights issue to prop up its balance sheet, on top of $13bn already raised from Singaporean and Middle Eastern investors. The chairman, Marcel Ospel, stepped down.

Meanwhile, Lehman Brothers, which had been seen as potentially the next Bear Stearns, managed to raise $4bn to shore up its own finances.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Naturally, share prices on both sides of the Atlantic rocketed

Is the worst behind us?

Why did share prices take off yesterday after investment banks raised even more capital to prop up their injured balance sheets? Well, it's the usual triumph of hope over experience.

Wall Street and the City are hoping that this little episode marks the beginning of the end for uncertainty over the financial system. Surely, after this latest write-off, UBS must have revealed the worst. And as for the $4bn fund-raising at Lehman the group had originally only been looking for $3bn. Demand was so strong from institutions that it jacked up its sale by another whole billion dollars.

So the hope is that we're starting to put the worst behind us, and soon we can all get back to business as usual.

However, there are a lot more things to worry about. Even if the latest write-downs represent a beginning to the clear-out, we won't see a return to the days of easy credit for a long, long time. Lehman Brothers' rights issue was over-subscribed, but it's not that surprising, given the terms on offer. The convertible preference shares pay a 7.25% dividend yield.

But as Adam Compton at RCM Investors told The Times: "If there is a question that a bank may need funds in the future, it is better to raise it sooner rather than later, because funding is only going to get more expensive."

Meanwhile, the problems in the financial world have spread far beyond the City and are now firmly entrenched in the real' economy. Even in the days before credit derivatives had become so widespread, a worsening economic environment was always bad news for banks. With so many other dodgy debt instruments linked to corporate defaults and credit card debt out there, we can expect to see more parcels of toxic debt revealing themselves as conditions worsen.

On employment, for example. there's the small question of what will happen to the 9,000 staff working in UBS's London offices, as well as all those other City staff who suddenly face an uncertain future.

Why Central London house prices aren't immune to the crunch

This is already having an impact on the Central London property market. Remember all those super-prime houses that property bulls kept saying could never fall in price? And all that stuff about oligarchs and wealthy oil sheikhs keeping London afloat, because it's such a great place to live?

Well, Knight Frank has just reported that sales of Central London homes worth between £1m and £5m fell by 20% in the first quarter. Apparently, houses in the £3m to £5m bracket were the worst affected.

Sure, it's City employees rather than wealthy Russians who are being forced out of the market by employment fears or because their bonuses are drying up. But most rich people didn't get rich by being stupid. The odd million pounds here or there might be peanuts to an oligarch, but he's still not going to pay £5m or £10m for something he reckons he'll be able to get 10% or 20% cheaper in a couple of year's time. Nobody likes losing money, particularly when the outlook for the global economy is so uncertain.

And how attractive will London look to party-loving foreign billionaires in the middle of a recession?

As for the rest of us, well, house prices for mere mortals are already in the doldrums, and now we hear that First Direct has just completely pulled out of offering mortgages to new customers. The bank has been swamped with demand for its products, including its 4.95% two-year fixed mortgage deal, seen as one of the most competitive currently on the market.

The HSBC-owned bank says the withdrawal is a "temporary measure." Chief executive Chris Pilling, told The Times: "Rather than increase interest rates dramatically to discourage new applications, we've decided to temporarily withdraw from offering mortgages to non-customers until we've cleared the backlog."

It's perhaps a more honest way of doing things, but it makes for some scary headlines. "Bank pulls out of mortgage market" is the front page of The Telegraph today. It might be the first, but it certainly won't be the last.

Turning to the wider markets

In London, the FTSE 100 leaped 150 points to end the day at 5,852. Banks and retailers were the main risers.

Across the Channel, the Paris CAC-40 jumped 177 points to end the day at 4,866. And in Frankfurt, the DAX-30 rose 186 points to 6,720.

On Wall Street, the Dow Jones rocketed 391 points to close at 12,656 as investors were heartened by strong demand for Lehman Brothers' stock offering. The broader S&P 500 gained 47 points, to 1,370, while the tech-heavy Nasdaq ended 83 points higher at 2,362.

In Asia, Japanese stocks followed the US higher, with the Nikkei rising 523 points, to 13,189.

Crude oil was trading at around $101.44 this morning, while Brent spot was a little higher, at $100.71.

Spot gold was trading at around $890 an ounce this morning. Platinum was broadly unchanged at around $1,936, while silver was trading at $16.95.

Turning to forex, sterling was trading at 1.9806 against the dollar, and at 1.2681 against the euro. The dollar was last trading at 0.6406 against the euro and 101.91 against the Japanese yen.

And this morning, UK retailer Woolworths reported that annual profits had fallen by 44%. The group has slashed its divided by two-thirds to conserve cash.

Our recommended articles for today...

Hang onto gold

- Timing is everything, but if you want to be a strong hand' investor, don't be too hasty to get out when it comes to commodities, writes John Robson & Andrew Selsby. Most commodity-based investments will continue to benefit from further dollar weakness. Despite its recent fall, there is still a bull market for gold - to learn why, read read: Gold's bull market

The real reason for the housing boom

- The housing bubble has burst because it was driven by credit, not supply and demand, as Merryn Somerset Webb has often pointed out. And with prices just starting to fall, things are only going to get worse. Find out why: Home sour home

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.