Jeremy Warner: HSBC's blockbuster rights further rattles skittish investors

So that wasn't so difficult, was it? After years of denial, HSBC has admitted that the acquisition of the US sub-prime lender Household was a mistake and put the business into run-off. That Household was a blunder was obvious to everyone else from the moment the business was acquired back in 2002, yet despite rising losses and impairment charges, HSBC was itself still insisting as recently as a year ago that Household was basically a good business with decent growth prospects.

With big companies, as with governments, there is frequently a difference between what is said publicly and the way things are viewed in private. One of the reasons HSBC couldn't bring itself to admit it had bought a pup is that to do so might have scuppered all chance of a relatively damage-free exit. Privately, HSBC has been casting around for acceptable solutions to the Household "problem" for at least two years, but failed to find anything that allowed the bank an honourable retreat.

The charade was thus maintained that eventually the Household acquisition would be vindicated. As long as the US looked as if it might avoid a serious recession, this was just about credible, but after confidence fell off a cliff last September it came to look ever more deluded and therefore ridiculous. Yesterday's blockbuster rights issue couldn't credibly have been launched unless accompanied by full recognition of the Household problem and a plan for dealing with it.

Thanks to a substantial and still booming Asian business, HSBC has thus far come through the credit crisis better than most. The operative term here, of course, is "better than most", for despite attempts to portray yesterday's rights issue as a precautionary measure aimed at making an already strong capital position even stronger, the results show clear signs of distress.

The dividend has been slashed, pre-tax profits are down 62 per cent, and the group admits the outlook has rarely looked more challenging.

The bulk of the damage, though not all of it, comes from Household, or what HSBC now calls its North American Personal Financial Services business.The Household acquisition can be viewed as a kind of proxy for the credit crisis as a whole. As Stephen Green points out in yesterday's statement, one of the root causes of the credit crunch was the global financial imbalances that arose out of the economic shift towards emerging markets.

With its strong Far Eastern presence, HSBC has been one of the major beneficiaries of these changes. Yet it also found itself with a surplus of deposits, or savings, with nowhere to go, much of it generated by booming emerging markets. Household seemed to the then chairman, Sir John Bond, to provide the perfect marriage of these new lenders with high-yield US borrowers.

Unfortunately, many of these borrowers turned out to be the now infamous Ninjas ("no income, no job, no assets). Once the sub-prime lenders of Household, constrained until that point by an absence of funding, got their hands on the strengths of the HSBC balance sheet, they let rip.

What HSBC did was in fact only the mirror image of what was happening on a macro-economic scale. Bizarrely, the savings of some of the poorest nations in the world were being used to fund the credit-fuelled consumption of some of the richest.

Is yesterday's blockbuster rights issue big enough to see HSBC through the storm, and if not, what does that say about other, less well- capitalised banks? The answer to the first question depends crucially on whether you think HSBC is being entirely up front about the scale of the Household damage.

Knight Vinke, the activist investor which has been a fierce critic of the HSBC board, thinks not. Knight Vinke's position is an odd one, for although some of its criticisms of HSBC have been proved fair comment, its apparent determination to demonstrate HSBC is essentially bust is completely at odds with the long position it holds in the shares. It behaves more like a short-selling hedge fund than a long-term investor, and frequently seems more interested in generating headlines than providing solutions.

Knight Vinke argues a superficially compelling case, and if the present downward spiral in asset prices persists, it may even be proved correct. But personally I think it flawed in two important respects. First, the activist investor seems to think there should be an immediate $34bn-plus impairment charge against the remaining $100bn Household loan portfolio. This is the difference between the carrying value of the assets, and HSBC's estimate of their "fair value" if they were all sold in a fire-sale tomorrow.

Yet HSBC doesn't propose to do such a thing, and nor would it be in anyone's interests to try in such depressed market conditions. Instead, HSBC is putting the book into run-off. More impairment charges over time are a certainty, but, assuming we are not heading into a repeat of the Great Depression, it shouldn't be as high as $34bn.

The same applies to the $21.3bn of asset-backed securities which HSBC's investment bank lists as available for sale. If they were all sold now at the same time, there would be an immediate and very sizeable charge which would eat deep into the new capital HSBC is raising from shareholders. But no banker in his right mind would liquidate in this way.

Nonetheless, if Knight Vinke is right, and the correct way of looking at Household and other HSBC assets is to use their "fair value", then obviously HSBC is in trouble. HSBC would not be the supremely well-capitalised bank it pretends. Indeed it would be worse capitalised than either Citigroup and UBS, both of which have had to be bailed out by government.

To avoid this potential calamity, Knight Vinke suggests HSBC walks away from Household altogether, or finds a negotiated way of handing it back to its bondholders. If it hangs on, even in run-off, Household could end up sinking the whole ship.

Again, I'm not sure this is a terribly helpful analysis. Banks cannot survive without trust and confidence, as the current crisis has amply demonstrated. If banks start reneging on their obligations to bondholders and other creditors, it really will be the end of the banking system as we know it.

Even if it were possible for HSBC legally to get away with such a cavalier approach to its subsidiaries – technically, the holding company is not a guarantor of the Household bonds – the systemic and reputational damage would likely outweigh any supposed benefits.

As I say, Knight Vinke may end up being proved correct. Banking is all about confidence. Once it goes, it doesn't matter how big your capital buffer, the bank will still fail. HSBC as a whole hasn't been as badly affected by the credit crunch to date because it is perceived of as a big, strong, global bank that can contain the Household problem and other localised areas of extreme difficulty.

Unfortunately, this is a crisis which has a habit of trouncing one line of defence after another. First the weakest banks were knocked down, then stronger and stronger ones. Those banks that have resorted to rights issues have found them easily broken by short-selling speculators.

The HSBC rights issue seems to be relatively well supported at this stage, and, even after yesterday's near-20 per cent fall in the share price, the discount is still a big one. But the issue could easily go the same way as HBOS and Royal Bank of Scotland. The price of the rights has given the bears something to aim at.

HSBC ought to be covered by the FSA ban on short selling now it has launched a rights issue. But that's not going to stop the speculators shorting the shares in Hong Kong, where the stock is actively traded. In any case, it is as if by launching a rights issue HSBC has lifted its veil a little and admitted its potential weaknesses and vulnerability.

It was another grim session for stock markets yesterday. The HSBC rights issue was only part of a heady cocktail of negatives that included the third government rescue in almost as many months of AIG in the US and further alarming economic data from China and the US.

The FTSE and the Dow are virtually back to where they were in 1996 when Alan Greenspan, then chairman of the US Federal Reserve, made his famous remarks about the "irrational exuberance" of stock markets. Having thought the Dow overvalued back then, he later changed his mind and fully bought into the idea that the new economy had transformed traditional yardsticks.

Yet even when of a saner disposition all those years ago, I doubt he would have thought the banks worth virtually nothing at all, which is the present position. HSBC is determined to resist use of either the Troubled Asset Relief Programme in the US or the Asset Protection Scheme in the UK. If we have already seen the bottom of the banking crisis, it might succeed. But if there's another downward lurch, don't bet on it.