One year on, this crisis is very far from over
Despite optimism in some quarters, there is plenty of evidence to suggest that we are just at the beginning of a profound and extended financial upheaval, says Alex Brummer
On 9 August, the credit crunch will mark its first anniversary. No one could have anticipated that almost a year after three investment funds at BNP Paribas were suspended (because of valuation problems) and the European Central Bank stepped into the money market with a massive €95 billion intervention, that the world would still be feeling the aftershocks.
Indeed, despite optimism in some quarters that the worst of the crisis is over, there is plenty of evidence to suggest that we are just at the beginning. The big freeze in the credit markets is persisting and the spillover into the real world of growth and jobs is only just starting.
There was a view that the rescue of the investment house Bear Stearns by JPMorgan, backed by the Federal Reserve in mid-March, marked the peak of the credit crisis that began in America’s trailer parks. Certainly, the willingness of Fed chairman Ben Bernanke, an expert on the Great Crash, to step in, was seen as a great confidence builder. Indeed, soon afterwards, the Bank of England – which found itself at the vortex of the credit crunch when Northern Rock ran into difficulties in the autumn of 2007 – ventured to suggest in its Financial Stability Report that the worst might be over.
There was no such complacency at the International Monetary Fund. When it produced its World Economic Outlook Report in the spring, it asserted that the total bill for the credit crunch would be a whopping $975 billion, described it as the greatest financial problem since the Great Depression, and slashed all its economic forecasts.
The evidence is growing that the IMF was right in its pessimism. Recent events suggest, certainly as far as Britain is concerned, that what began as a very American crisis – with its roots in overstretched US housing and mortgage markets – is spreading like wildfire. Nations with the most overstretched economies, like the UK and Spain, have been hit hardest. A look at the Paris-based OECD’s index of leading economic indicators shows that with the exception of Russia, the health of markets and the economies across all the other advanced nations are heading in the wrong direction.
The subprime crisis itself is far from over. Last month saw two major US financial institutions, Wachovia (once seen as a merger candidate for Merrill Lynch) and Washington Mutual (of the Pacific North-West) remove their top officials. The Wall Street firm Lehman Brothers, which wobbled at the time of the Bear Stearns rescue, is even being touted as a possible takeover candidate, with Barclays Capital, among others, mentioned as a possible suitor.
The events at Bradford&Bingley in June, although on a small scale, illustrate the vulnerability of credit markets to fresh shocks. The buy-to-let mortgage lender was required to bring in a new investor, Texas Pacific Group (TPG) and change the terms of its £300 million rights issue because of sharp deterioration in trading conditions which had turned a profit into a loss in the first four months of the year.
Much of the debate about the events at B&B has focused on the betrayal of the underwriters and the burden on shareholders. But there is little doubt that without the intervention of a white knight in the shape of TPG and the care and attention of Britain’s tripartite authorities – the Treasury, the Bank of England and the Financial Services Authority – B&B could have been Northern Rock Mark II.
B&B claimed throughout that it had a trading problem, not a funding problem like Northern Rock (described by some as National Wreck). Yet the changes in trading conditions which caused B&B problems are common to much of the UK mortgage sector. The housing market is in sharp decline, according to both the Nationwide and Halifax indices, and the most gloomy forecasts suggest that it could fall by 25 per cent. The problems may be most acute in the market for new homes in the inner cities, but the fact remains that arrears and repossessions across the board are on the rise.
When the last batch of UK bank trading statements were unveiled in the spring, the big write-downs were the result of American subprime coming home to roost. This forced the big rights issues at Royal Bank of Scotland and, to a lesser extent, Halifax Bank of Scotland. The big story in the coming months will be of the home-grown impairment at our mortgage banks. It is also entirely possible that if the mortgage book of Northern Rock were to deteriorate sharply, as a result of irresponsible loans made in the early months of 2007, the taxpayer could be on the hook for a great deal longer than expected. The prospects for Granite, the Rock’s securitised loan arm which was not nationalised, could be damaged.
One of the enduring difficulties, on both sides of the Atlantic, is the failure of money markets to normalise despite big interest-rate cuts in the United States and the three-quarter point cuts in rates to 5 per cent here in the UK despite the inflation threat.
The gap between official rates and money market rates is still much wider than the historical average. So banks are having to take extraordinary marketing steps to attract loans. HBOS, which has exposure to buy-to-let through its Birmingham Midshires arm, has launched a short-term savings offer of 10 per cent (12 per cent in the case of those with a deposit of £5,000 already in the bank) for anyone committing to make regular savings over a 12-month period. Such determination to grab retail savings shows how hard it has become to attract deposits in the wholesale markets where, despite widespread recapitalisation, the level of distrust is still acute.
The list of unsolved and developing difficulties in the credit markets remains as long and as intractable. Different accounting rules mean that whereas subprime loans and their derivatives have been marked down to market in the US, this is not the case in other jurisdictions where there may be further impairment to come. New categories of problems are arising, such as home equity loans in the US – which allowed people to withdraw equity in the good times – and where repayments have become difficult.
The US mortgage intermediaries Fannie Mae and Freddie Mac have been hard hit by the downturn in housing and problems in securitised mortgage lending and may need a government bail-out. And the so-called ‘monoline’ insurers, MBIA and Ambac among them, which insured subprime debt, are in danger of a ratings downgrade that could leave them and their clients facing a new round of losses.
Central banks and regulators have been remarkably successful in putting fingers in the dyke and preventing contagion – the process where a crisis in one financial organisation spreads to another becoming systemic. This has allowed time for a rebuilding of balance sheets with Royal Bank of Scotland joining Citibank, Merrill Lynch, Morgan Stanley and others in stabilising their balance sheets.
But there is also a recognition that it is not just home loans and subprime that are contaminated. The credit crunch is a response to a worldwide boom in credit which has rapidly come to a halt. The supply of loans to real estate, corporations and even emerging market countries is drying up at a time when incomes are being squeezed by higher energy and food prices.
The world is in for a hard landing and the global economy could remain grounded for a long time.
Alex Brummer is City editor of the Daily Mail. His book The Crunch: Uncovering the Truth Behind the Great Credit Scandal is published by Random House on 2 July