Showing posts with label Credit crunch. Show all posts
Showing posts with label Credit crunch. Show all posts

Thursday 10 December 2020

The health of the credit system is crucial

Periods of healthy credit growth bear no psychological resemblance to the extreme exuberance of manias or the extreme caution or fear of debts (debtophobia).


The health of the credit system in 2008

When the global financial crisis hit in 2008, countries like the United States were vulnerable because they had been running up debt too fast.

In Southeast Asia, however, the opposite story was unfolding.  Indonesia, Thailand, Malaysia and the Philippines had manageable debt burdens and strong banks ready to lend, with total loans less than 89% of deposits.

Over the next 5 years, post 2008, the health of the credit system would prove crucial:

  • nations such as Spain and Greece, which had seen the sharpest increase in debt before 2008, would post the slowest growth after the crisis;
  • nations such as the Philippines and Thailand, which had seen the smallest increase in debt during the boom, would fare the best.


How the credit cycle works in brief

Rising debt can be a sign of health growth, unless debt is growing much faster than the economy for too long.

The size of the debt matters, but the pace of increase is the most important sign of change for the better or the worse.

The first signs of trouble often appear in the private sector, where credit manias tend to originate.

The psychology of a debt binge encourages lending mistakes and borrowing excesses that will retard growth and possibly lead to a financial crisis.

The crisis can inspire a healthy new caution, or a paralyzing fear of debt (debtophobia).

Either way, the period of retrenchment usually lasts only a few years (usually 4 to 5 years). #  

The country emerges with lower debts, bankers ready to lend, and an economy poised to grow rapidly.



Additional notes:

# On average, credit and economic growth remained weak for about four to five years.

In Asia, credit fell in the five years after 1997 by at least 40 percentage points as a share of the GDP in Indonesia, Thailand and Malaysia.  But within about four years, the gloom had started to lift as debts fell, government deficits declined, and global prices for the region's commodity exports rose.  Credit growth picked up, and the average GDP growth rate in these three Southeast Asian economies rose from around 4% between 1999 and 2002 to nearly 6% between 2003 and 2006.

Tuesday 14 February 2012

Australia is caught in a credit crunch and the banks just made it worse, not better.

Banks' rate moves reveal system cracks

David Llewellyn-Smith
February 13, 2012

The media reaction to the banks' Friday rate hikes has been dominated by a schoolyard binary construction of the problem: the banks versus the government.
Some have taken the side of the government, that the banks are a greedy bunch of so and sos. Most have taken the side of the banks, that the government has no right to interfere in private business decisions.
Laudable sentiments if the banks are private. Which they are not. But let that pass.
This columnist has already written that what's really at stake here is the political economy of banking and the government's failure to openly address that fact is now coming back to haunt it.
Instead this column will argue a much simpler point: Australia is caught in a credit crunch and the banks just made it worse, not better.
How so? To understand you have to have a handle on the basic tenets of banking. Like all businesses, banks have a balance sheet. There are two halves to the balance sheet: assets and liabilities.
For banks it's a little confusing because outgoing loans - for houses, cars etc. - are in fact assets. They are the stuff from which banks draw an income.
The bank's liabilities are also loans, but those taken from others, like deposits or bonds. The difference between these two is the bank's equity or capital base.
The ratio between the amount of capital and total assets is called the leverage. It's the number of times against which the bank's capital has been multiplied in its outgoing lending book.
That's it, not so hard.
Trouble triggers
There are two ways in which a bank can find itself in trouble. The first and most common is when its assets - the loans it has given to its clients - deteriorate in quality.
This problem happens when the folks who borrowed the money struggle to repay it. They might have lost their job, or the asset they offered as collateral against the loan - say, a house - may have lost value and their own balance sheet is under pressure.
If they sell, they can't repay the whole loan amount. You can see how this process can feed upon itself as distressed sales leads to more falling prices.
At a certain stage the banks themselves get into trouble as enough assets are impaired and their capital begins to decline. They must then restrict lending and the problem gets worse again. This is called a credit crunch.
This is what happened in the US. Australia is also in the early stages of such a process with falling house prices, rising unemployment and rising impaired loans at the banks. It's difficult to judge how far into this we are and whether it can be reversed.
The jobs generated by the mining boom offer the hope that it is possible to arrest the decline and instead of a credit crunch we get a stall in housing and a redistribution of capital elsewhere.
The primary protection against the process getting out of control is monetary policy, or interest rates, which can be lowered to alleviate the borrower stress at the heart of the problem.
Nervous creditors
The second way in which a bank can find itself in trouble is on the other side of the balance sheet: the liabilities. This happens when the people lending money to the bank - depositors or investors - get nervous and want a higher interest rate to give the bank their money.
In the past this was not much of a problem for Australian banks as they relied upon steady deposits. However, after the new millennium began, the banks went a bit nuts borrowing less stable money from investors here and abroad and loaned that money largely to punters betting on houses.
Now, through a combination of the troubles in Europe, the fact that the process of deteriorating assets is under way, and through their own incompetence in the mishandling of covered bonds, investors want much higher interest rates to lend our banks money.
So yes, they need to raise interest rates to extract more money from the other side of the balance sheet to compensate. If they don't then they'll not be able to lend money on unprofitable loans and the credit crunch still transpires as the banks limit the supply of credit.
In short, whichever way the banks turn right now, whether they pass on their borrowing costs to mortgagors and put downward pressure on their assets, or they absorb the higher funding costs and stop making unprofitable loans, we edge further into a credit crunch. And indeed, as you can see, the two halves of the balance sheet aren't at all separate.
Credit crunch
As risk builds in one then it has a deleterious effect on the other and so another feedback loop threatens. This is systemic stress and is exactly where we are now, whether you want to blame the government or the banks (or, in this writer's case, the politico-housing complex).
So, the only question that matters right now is this: can the RBA arrest this developing feedback loop by cutting interest rates?
To my mind it is now clear that the central bank, which handled its actions flawlessly last year, erred dramatically last week in staying on hold.
By pushing the banks to hike unilaterally, the first time in history, the banks have shaken the foundation of the one commonly (and sensibly enough) held truth in Australian asset markets, that when asset prices decline, unemployment or other economic adversity threatens, the RBA will save us by cutting interest rates.
The insurance is still there but a nasty crack now runs through its base and this commentator can only see this making asset markets worse.
We're into a credit crunch all right.
David Llewellyn-Smith is the editor of MacroBusiness and co-author of the Great Crash of 2008 with Ross Garnaut. This is an edited version of a longer article available free at MacroBusiness.


Read more: http://www.smh.com.au/business/banks-rate-moves-reveal-system-cracks-20120213-1t0ce.html#ixzz1mIsQMilO





All the Big Banks lift Rates


Eric Johnston
February 13, 2012 - 5:46PM

ANZ won't rule out more job cuts

Despite slashing 1000 jobs and raising mortgage rates to protect profit margins, ANZ Australia CEO Philip Chronican says there could be more pain.
The Commonwealth Bank and National Australia Bank have become the latest banks to raise their variable lending rates outside the Reserve Bank's regular monthly cycle.
National Australia Bank this evening said it would lift its standard variable home loan interest rate by 9 basis points to 7.31 per cent.
Earlier, the Commonwealth Bank, Australia's biggest mortgage bank, announced that its standard variable mortgage rate will rise 10 basis points to 7.41 per cent from February 20.
CBA AFR 090827 MELB PIC BY JESSICA SHAPIRO...GENERIC commonwealth bank, banker, interest rates, big four, four pillars, pedestrians, customers.AFR FIRST USE ONLY PLEASE!!! DIGICAM 112727
Commonwealth Bank and regional lender Bendigo and Adelaide Bank become the latest banks to break ranks with the RBA. Photo: Jessica Shapiro
The moves round out the out-of-cycle rate rises among the big four banks.
Also today, Bendigo and Adelaide Bank increased its standard variable mortgage rate 15 basis points to 7.45 per cent.
Westpac and the ANZ defied Treasurer Wayne Swan and lifted variable rates 0.10 and 0.06 percentage points respectively, on Friday, despite a decision by the Reserve Bank to hold its cash rate steady. The ANZ bank today announced it would cut 1000 jobs by September 30 to cope with weaker demand for banking services.
Rising costs
As with other banks, CBA blamed today's rate increase on rising funding costs, adding that greater uncertainty emanating from Europe was exacerbating the situation.
“In making this decision, we have been cognisant of our total funding costs, of which the official cash rate is only one factor,’’ said CBA group executive of retail banking Ross McEwan.
‘‘The Commonwealth Bank believes Australian banks should continue to price sensibly, taking into account factors both on and offshore, rather than experience similar problems to those that many banks overseas have experienced,’’ Mr McEwan said.
"Whilst we understand that any increase in interest rates is not favourable to borrowers, our millions of deposit customers are favoured and since the commencement of the GFC we have seen significant competition in retail deposits pricing," he said.
CBA said it would raise the interest rate on its six-month term deposit account by 20 basis points, also effective February 20.
National Australia Bank, the last of the four big banks to announce its interest rate stance, said it is reviewing its rates.
Commonwealth Bank shares rose 41 cents, or 0.8 per cent, to $50.29, slightly less than the overall market's gain. Bendigo and Adelaide Bank shares rose 6 cents, or 0.7 per cent, to $8.19.
Bendigo move
Bendigo, like ANZ, has also said it would review interest rates independently of the Reserve Bank. Westpac's new variable mortgage rate is 7.46 per cent and ANZ's is 7.36 per cent.
Bendigo managing director Mike Hirst said current banking margins are not sustainable and adjustments to interest rates must be made.
“This is not a popular move, we know that, but it is the right thing to do to restore a proper balance between depositors, borrowers, the Bank’s shareholders and our community partners. At current funding cost levels that balance is out,” he said.
At current pricing levels banks were “subsidising mortgages,” Mr Hirst said.
“If you look at the traditional role of a bank this makes no sense and is unsustainable,” he added.
Mr Hirst said banks had a fundamental choice to make: adjust the pricing on loans or restrict lending. He added the latter option would have significant implications for the economy and would not be the right thing to do at this point in time.
He also said many staff at Bendigo have taken unpaid leave to help reduce costs, while no new back office staff are being hired.
Bendigo’s new mortgage rate will apply from February 21.
ejohnston@theage.com.au, with Chris Zappone


Read more: http://www.smh.com.au/business/all-the-big-banks-lift-rates-20120213-1t1ae.html#ixzz1mIuF0oCu

Monday 23 February 2009

Why did no one see the credit crunch coming?

The Queen's tough question about the credit crunch has not been answered
Why did no one see the credit crunch coming? That was the awkward question Her Majesty the Queen asked on a visit to the London School of Economics last year.

By Peter Spencer
Last Updated: 9:32PM GMT 22 Feb 2009

Comments 18 Comment on this article

It would make a useful addition to many economics and finance examination papers this summer.

I would argue that it was hard to predict simply because nothing like this has ever happened before. History is littered with financial crises, but the collapse of the market in liquidity that lies at the heart of this problem is almost without precedent. The only case I am aware of is the collapse in international trade finance that took place after the assassination of the Archduke Ferdinand in Sarajevo, in the run up to the First World War.

The roots of this collapse lie in the global imbalances that have been building up for decades, making the world economy increasingly vulnerable. Huge savings in Asia depressed world interest and inflation rates and were channelled through the US banking system to western borrowers, reinforced since the millennium by the flow of petrodollars.

That helped drive the boom in UK mortgage and housing markets and the fall in the saving ratio. In 2006 our mortgage lenders were handing out £10bn of mortgages every month – and only getting in £5bn of that from savers. The rest was coming in from overseas banks.

The result was an overseas debt of £740bn between 2000 and 2006 – worth more than half of our gross domestic product – typically with a very short maturity. These dollar inflows had to be converted into sterling, which is why the exchange rate was so strong and exports so weak.

I think we all knew it could not last. It didn't matter whether you looked at the global imbalances; the level of house prices, or the 125pc mortgages that lenders were blithely handing out: this was clearly unsustainable.

People had been predicting a sticky end for years, but the dance just went on and on. Gordon Brown was repeatedly warned of the risk we were running with high levels of borrowing by the OECD, the IMF and other institutions. However, the music was so loud he could not hear.

He was not the only one. The Bank for International Settlements clearly warned of the threat to the global financial system posed by financial engineering and high levels of leverage. However, the markets refused to listen and just carried on dancing.

When it finally came, the end of the credit boom was much more sudden than anyone imagined. Like myself, most economists thought in terms of a gradual rebalancing as the debts built up and house prices became unaffordable, with the brakes applied gently. We expected things to turn round gradually, moving in a cyclical way rather than screeching to a halt. The surprise was that this time the international banking markets simply froze, suddenly halting the inflows into sterling and the credit markets. So what we got was more like a car crash. The economy had to adjust suddenly rather than, as we thought, gradually

Regrettably, very few were wearing seat belts. Now all of those heavy short term debts have to be repaid. Northern Rock was of course the first casualty, and the housing market quickly followed, dragging the rest of the economy into recession. The pound has been another casualty.

As I say, economists usually expect things to turn round gradually rather than abruptly. Financial markets can turn on a sixpence, but they usually remain open for business, even after a stock market crash. As Hyman Minsky observed, credit markets swing from elation and speculation to panic and contraction. But they have not shut down before, at least in peacetime.

Interest rates and financial prices can react violently in a crisis, but usually they manage to get demand back into line with supply. If confidence collapses it may take a big fall in the stock market to tempt bargain hunters back in, but eventually this happens.

Credit markets seem easier to understand than the stock market but are actually much more complex. If the supply of bank finance is cut, interest rates will normally rise to help bring demand into line with supply. But as Joseph Stiglitz pointed out in a famous paper with Andrew Weiss in 1981, this will discourage prudent borrowers who tend to be price sensitive, increasing the proportion of bad risks on the loan book. It is hard to prevent this: bank managers can't really distinguish the bad risks; otherwise they would not get a loan in the first place. Credit risk rises, particularly if a recession results, meaning that a rise in the loan rate can actually reduce the profitability of the loan book.

In this situation, banks tend to ration their customers rather than raising rates any further. A similar effect seems to have shut down the inter-bank and other wholesale credit markets in August 2007. Inter-bank rates naturally moved up as the market began to worry about bank losses on sub-prime loans.

But they reached a point at which they began to raise questions about the borrower's ability to repay. Any bank that was prepared to pay 1pc or so over the odds clearly had a liquidity problem. It might also have a solvency problem, especially if it was relying on high cost wholesale funds to fund a historic portfolio of low cost mortgages. So any banks that did have surplus cash simply hoarded it rather than risking it.

Of course there was more to it than that. Once Northern Rock failed, it became clear that wholesale depositors could not rely on the bank regulators to monitor the banks properly.

This also raised doubts about the Bank of England's ability to help out banks without stigmatising them, even if they just had a temporary problem with their liquidity.

Moreover, when the credit markets dried up it was no longer possible to place a market value on many of the banks assets. But whatever the reasons for this, the banks simply stopped lending to each other. Then they stopped lending to us.

Peter Spencer is Professor of Economics and Finance, University of York and Economic Adviser, Ernst & Young ITEM Club

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4782758/The-Queens-tough-question-about-the-credit-crunch-has-not-been-answered.html

Sunday 15 February 2009

Without a cure for toxic assets, credit crisis will persist

Without a cure for toxic assets, credit crisis will persist
By Steve Lohr

Friday, February 13, 2009
NEW YORK: Many of the large U.S. banks, according to economists and other finance experts, are like dead men walking.

A sober assessment of the growing mountain of losses from bad bets, measured in today's marketplace, would overwhelm the value of the banks' assets, they explain. The banks, in their view, are insolvent.

None of the experts' research focuses on individual banks, and there are certainly exceptions among the 50 largest banks in the country. Nor do consumers and businesses need to fret about their deposits, which are federally insured. And even banks that might technically be insolvent can continue operating for a long time, and could recover their financial health when the economy improves.

But without a cure for the bad-asset problem, the credit crisis that is dragging down the economy will linger, as banks cannot resume the ample lending needed to restart the wheels of commerce. The answer, the economists and experts say, is a larger, more direct government role than in the Treasury Department's plan outlined this week.

The Treasury program leans heavily on a sketchy public-private investment fund to buy up the toxic, mortgage-backed securities held by the banks. Instead, the experts say, the government needs to plunge in, weed out the weakest banks, pour capital into the surviving banks and sell off the bad assets.

It is the basic blueprint that has proved successful, they say, in resolving major financial crises in recent years. Such forceful action was belatedly adopted by the Japanese government from 2001 to 2003, by the Swedish government in 1992 and by Washington in 1987 to 1989 to overcome the savings and loan meltdown.

"The historical record shows that you have to do it eventually," said Adam Posen, a senior fellow at the Peterson Institute for International Economics. "Putting it off only brings more troubles and higher costs in the long run."

Of course, the stimulus plan put forward by the administration of President Barack Obama could help to spur economic recovery in a timely manner and the value of the banks' assets could begin to rise.

Absent that, the prescription would not be easy or cheap. Estimates of the capital injection needed in the United States range to $1 trillion and beyond. By contrast, the commitment of taxpayer money is the $350 billion remaining in the financial bailout approved by Congress last fall.

Meanwhile, the loss estimates keep mounting.

Nouriel Roubini, a professor of economics at the Stern School of Business at New York University, has been both pessimistic and prescient about the gathering credit problems. In a new report, Roubini estimates that total losses on loans by American financial companies and the fall in the market value of the assets they hold will reach $3.6 trillion, up from his previous estimate of $2trillion. Of the total, he calculates that American banks face half that risk, or $1.8 trillion, with the rest borne by other financial institutions in the United States and abroad.

"The United States banking system is effectively insolvent," Roubini said.

For its part, the banking industry bridles at such broad-brush analysis. The industry defines solvency bank by bank and uses the value of a bank's assets as they are carried on its books, rather than the market prices calculated by economists. "Our analysis shows that the banks have varying degrees of solvency and does not reveal that any institution is insolvent," said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, a trade group whose members include the largest banks.

Roubini's numbers may be the highest, but many others share his rising sense of alarm. Simon Johnson, a former chief economist at the International Monetary Fund, estimates that the U.S. banks have a capital shortage of $500 billion. "In a more severe recession, it will take $1 trillion or so to properly capitalize the banks," said Johnson, an economist at the Massachusetts Institute of Technology.

At the end of January, the IMF raised its estimate of the potential losses from loans and other credit securities originated in the United States to $2.2 trillion, up from $1.4 trillion in October. Over the next two years, the IMF estimated, U.S. and European banks would need at least $500 billion in new capital, an estimate more conservative than those of many economists.

Still, those numbers are all based on estimates of the value of complex mortgage-backed securities in a very uncertain economy. "At this moment, the liabilities they have far exceed their assets," said Posen of the Peterson Institute. "They are insolvent."

Yet, as Posen and other economists note, there are crucial issues of timing and market psychology that surround the discussion of bank solvency. If one assumes that current conditions reflect a temporary panic, then the value of the banks' distressed assets could well recover over time. If not, many banks may be permanently impaired.

"We won't know what the losses are on these mortgage-backed securities, and we won't until the housing market stabilizes," said Richard Portes, an economist at the London Business School.

Raghuram Rajan, a professor of finance and an economist at the University of Chicago graduate business school, draws the distinction between "liquidation values" and those of calmer times, or "going concern values." In a troubled time for banks, Rajan noted, analysts are constantly scrutinizing current and potential losses at the banks, but that is not the norm.

"If they had to sell these securities today, the losses would be far beyond their capital at this point," he said. "But if the prices of these assets will recover over the next year or so, if they don't have to sell at distress prices, the banks could have a new lease on life by giving them some time."

That sort of breathing room is known as regulatory forbearance, essentially a bet by regulators that time will help heal banking troubles. It has worked before. In the 1980s, during the height of the Latin American debt crisis, the total risk to the nine money-center banks in New York was estimated at more than three times the capital of those banks. The regulators, analysts say, did not force the banks to value those loans at the fire-sale prices of the moment, helping to avert a meltdown of the banking system.

In the current crisis, experts warn, banks need to get rid of bad assets quickly. The Treasury's public-private investment fund is an effort to do that.

But many economists and other finance experts say that the government may soon have to move in and take on troubled assets itself to resolve the credit crisis. Then, they say, the government could have the patience to wait for the economy to improve.

Initially, that would put more taxpayer money on the line, but it might reduce overall losses if the government-controlled entity were a shrewd seller. That is what happened during the savings and loan crisis, when the troubled assets, mostly real estate, were seized by the Resolution Trust Corp., a government-owned asset manager, and sold over a few years.

The eventual losses, an estimated $130 billion, were far less than if the hotels, office buildings and residential developments had been sold immediately.

"At the end of the day, the taxpayer money would be used to acquire assets, and behind most of those securities are mortgages, houses, and we know they are not worthless," said Portes, the London Business School economist, who is president of the Center for Economic Policy Research.

"So the taxpayers would not be out anything like the back-of-the-envelope, headline numbers people toss around."


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Copyright © 2009 The International Herald Tribune www.iht.com

http://www.iht.com/articles/2009/02/13/business/insolvent.php

Saturday 14 February 2009

Credit crunch

Synchronised drowning
By Christopher Hughes

Credit crunch: More than 18 months into the financial crisis, some observers are saying that things just might have stopped getting worse. But even cautious optimism is hard to square with what companies are saying and doing.

True, some recent business surveys – in the US, eurozone, UK and China – showed sentiment rising, albeit from dismal levels. The Baltic Dry Index of shipping rates has doubled although it is still down 90% from its peak last May. Goldman Sachs said its Global Leading Indicator (GLI) suggests “a trough in the global industrial cycle may be in sight”.

But the credit crisis continues to advance with tragic predictability. Ferretti, the Italian yacht maker which epitomised the easy wealth and casual leverage of the credit boom, has skipped an interest payment on its acquisition debt, according to Bloomberg. Hammerson, a UK commercial property developer, announced a rights issue on Monday. And Germany's Schaeffler is battling against a break-up after loading up on debt to gain control of Continental, another heavily indebted German car parts maker.

This is a global crisis. India’s largest discount retailer, Subhiksha Trading Services, suffered widespread vandalism this weekend after running out of cash to pay security staff. The company reportedly admitted to having “mucked up on not raising equity”. In the Far East, suffering is the order of the day. Japanese carmaker Nissan forecasts big losses and Korean electronics producer LG warns revenues, expressed in dollars, will be down 20% this year.

Of course, bad news will keep flowing freely until well after the recession’s trough is crossed. So perhaps the worst is indeed almost upon us. But a more plausible interpretation of the less bad surveys is that the rate of decline has slowed. After the failure of Lehman Brothers last September, credit markets were frozen and modest GDP growth turned suddenly into rapid shrinkage. The shrinkage may now be proceeding at a more moderate pace.

But whether the times are pitch black or only very stormy, there are always opportunities to make money, if only from companies under pressure. Private equity firms specialising in secondary buyouts see rich pickings in the portfolios of capital-constrained banks that are looking to sell what assets they can. And Frank Quattrone, the former Credit Suisse banker who became synonymous with the excesses of the technology boom, is expanding his boutique advisory firm into London. He expects a spurt in tech mergers. As they say, there is always a bubble inflating somewhere.

chris.hughes@breakingviews.com

http://www.breakingviews.com/2009/02/09/credit%20crunch.aspx?sg=telegraph2

Wednesday 11 February 2009

Credit markets easing

Feb 11, 2009
Credit markets easing

WASHINGTON - US Federal Reserve chairman Ben Bernanke said on Tuesday the vast array of special central bank programs appear to have helped ease a credit crunch that has been choking economic activity.

Appearing before the House of Representatives Committee on Financial Services, Bernanke said that measuring the impact of the Fed's programs 'is complicated by the fact that multiple factors affect market conditions'.

'Nevertheless, we have been encouraged by the responses to these programs, including the reports and evaluations offered by market participants and analysts,' he stated.

'Notably, our lending to financial institutions, together with actions taken by other agencies, has helped to relax the severe liquidity strains experienced by many firms and has been associated with considerable improvements in interbank lending markets.'

Mr Bernanke said that in the past year since the Fed and other central banks began efforts to pump liquidity into the financial system, there have been signs of improvement.

He said this is notable in the lowering of the Libor, or London interbank rate, used among banks for short-term loans. He also said corporate short-term borrowing terms have improved since the Fed entered the commercial paper market.

Additionally, he said a drop in US mortgage rates may help steady the critical housing market.

'All of these improvements have occurred over a period in which the economic news has generally been worse than expected and conditions in many financial markets, including the equity markets, have worsened,' he added. -- AFP

http://www.straitstimes.com/Breaking%2BNews/Money/Story/STIStory_336882.html

Sunday 30 November 2008

US Subprime: History of the Credit Crunch and Credit Crisis

US Subprime: History of the Credit Crunch and Credit Crisis

Geneva, 3 nov 2008.
In this multi-part series, we uncover the events that led to the subprime credit crunch, and analyze future financial prospects.

Part 1: INFLATING THE BUBBLE
Part 2: BURSTING THE BUBBLE
Part 3: CONFIDENCE
Part 4: UNWINDING
http://www.economywatch.com/us-subprime/History_of_subprime_credit_crunch_part_4.html


What now?

Well, this is difficult to predict as we are in uncharted territory. It has taken time for the severity of the situation to sink in with most governments. If they have been to slow to react, the IMF has given them a shake up this weekend by saying that we could see a major melt down in the world financial system if governments do not take strong action. As I write, more and more governments are coming out to support their banks.

We can be sure we are not at the end yet. There is more bad debt on the books of the banks that has not been fully written off yet. A change in accounting rules may stave off some of this, but there is still a problem. The equity markets are badly shaken and will undoubtedly be very volatile for some time to come.

The shock of it all has triggered a lack of confidence which takes time to be restored and will affect us all. The removal of the credit mountain will cause an economic slowdown, but the worry that ensues will filter down to the consumer, who will stop spending - even if he has the money to spend - and this will push the slowdown into recession. There is much pessimism around and many comparisons to the great depression of the 1930s. You have to remember when assimilating the news that bad news sells papers and keeps people glued to the news channels, far more than good news. Gloomy predictions sell better than optimistic ones. The news channels know this.

America is likely to bear the worst brunt of this, with UK close behind and then Europe. It is harder to predict the effect on the emerging markets. They will undoubtedly slow down as their export markets dry up, but the larger emerging countries have started to develop a domestic market and a new middle class and they do not carry the bad debt of the western banks. China is sitting on over $500 billion of US Treasury Bills. However, China has already started to feel the impact of a slow down with some 20 million jobs being lost already this year, according to the Sunday Times. This sounds a lot, but you have to remember they have population of over 1.3 billion, - more than 4.3 times that of USA.