Market crisis: Even Armageddon has a silver lining
These look dark days indeed. People in and around the financial markets are muttering about credit crunches, hidden losses and sub-prime meltdown. Wackier Wall Street commentators are calling it ‘Armageddon’.
Of course, anyone close to the markets is likely to be working for an investment bank, hedge fund or private-equity firm, all of which have had an extraordinary run of big profits in recent years on the back of the ultra-cheap money that has been slopping around the world. They are bound to get upset when the music stops.
So should ordinary people be worried about the turmoil sweeping the world”s credit markets? Are economies going to be damaged and jobs lost? Are we going to have to pay for the excesses of the financial markets, rather like a waiter who ends up paying the bill for a banker”s lavish lunch? At the moment, there is little reason to worry. The world is no longer as reliant on the US locomotive as it used to be, and that”s a good thing. It is also worth remembering what happened after the 1987 stock markets crash. World central banks busily cut interest rate to avert a meltdown. But there was no meltdown and the world economy boomed.
And right now, the world economy has a lot of momentum in virtually every corner. Sure, the housing market looks dreadful in the US, with prices actually falling. But the economy is not in recession, unemployment is low and company profits at record levels.
So what do the events of last week tell us? Thursday and Friday, it has to be said, looked alarming enough to worry even the stoutest of souls. The European Central Bank, US Federal Reserve and other central banks injected a total of $323 billion of liquidity into the banking system to ensure there was enough cash for nervous investors to hold. That appeared to calm markets and brought down overnight lending rates. The Bank of England did not need to announce an injection of funds as it has a permanent facility for nervous banks to draw on.
The latest bout of uncertainty started on Thursday when the French bank BNP Paribas said it had stopped withdrawals from three investment funds because of an ‘evaporation of liquidity’. The German central bank, the Bundesbank, said it was organising a EUR 3.5bn bailout of the German lender IKB, which had run into trouble lending into the US sub-prime market.
You’d expect European banking shares to fall if investors fear some of them may have got their fingers burnt in the sub-prime market in the US. This demonstrates the global nature of modern financial markets. Loans going wrong in the US are claiming casualties around the world. The flip side of this is a positive thing: as the Bank of England governor, Mervyn King, pointed out last week, it means better sharing of risk around the world. These ‘collateralised debt obligations’ and other credit derivatives may sound like financial mumbo-jumbo but they do help to spread risk more widely, and outside the banking system. That should make the world of finance more resilient to shocks such as the current crisis.
The turmoil was an accident waiting to happen. The Bank of England had warned about the growth of ‘leverage’ (borrowing) and the ‘search for yield’ for years and has been urging banks of all sizes to ‘stress-test’ their exposure to different financial instruments in case events like this should happen. Firms around the world are sitting on plenty of cash, so can finance their own investment without resorting to banks. The banking system, too, is strong and profitable, so it is in good shape to withstand tremors as the pricing of risk by markets returns to more normal levels.
UBS analysts in London, commenting on the ECB cash injection, said: “We continue to stress that fundamentals, both on a macro and company level, are intact and that we believe the risk of the credit turbulence to spread into the overall economy is limited.”
Gilles Moec, at Bank of America, said: “Market turmoil, in itself, seldom has a significant impact on the real economy. However, the current financial turmoil can be interpreted as a global re-pricing of risks, after a long phase during which interest rates remained significantly below the levels warranted by fundamentals.” One could argue that the problems sweeping financial markets are a good thing. Investors need reminding that there are no one-way bets.
The list of banks that have lost money through their exposure to the sub-prime market seems to be growing longer by the day. But banks in general have very strong balance sheets at the moment, itself a reflection of the strength of the world economy in recent years. There are
probably more banks with some loans that have turned bad, and the failure of a big bank could cause the sort of systemic failure that King mentioned. But for now, even if Porsche dealerships are worried, most of us outside the banking and market arena can sleep safely and watch the drama unfold. — The Guardian