Upcoming Crisis May Make Crash Of ‘29 Look Like “A Walk In The Park”
Faces of power: The Fed’s Ben Bernanke, the BoE’s Mervyn King, the ECB’s Jean-Claude Trichet
As central banks continue to splash their cash over the system, so far to little effect, Ambrose Evans-Pritchard argues things are rapidly spiralling out of their control.
Holiday cheer from the Telegraph:
Twenty billion dollars here, $20bn there, and a lush half-trillion from the European Central Bank at give-away rates for Christmas. Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects.
As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world’s central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.
“Liquidity doesn’t do anything in this situation,” says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.
“It cannot deal with the underlying fear that lots of firms are going bankrupt. The banks and the hedge funds have not fully acknowledged who is in trouble. That is the critical issue,” she adds.
Lenders are hoarding the cash, shunning peers as if all were sub-prime lepers. Spreads on three-month Euribor and Libor - the interbank rates used to price contracts and Club Med mortgages - are stuck at 80 basis points even after the latest blitz. The monetary screw has tightened by default.
York professor Peter Spencer, chief economist for the ITEM Club, says the global authorities have just weeks to get this right, or trigger disaster.
“The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are allowing the money markets to dictate policy. We are long past worrying about moral hazard,” he says.
“They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don’t think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park,” he adds.
The Bank of England knows the risk. Markets director Paul Tucker says the crisis has moved beyond the collapse of mortgage securities, and is now eating into the bedrock of banking capital. “We must try to avoid the vicious circle in which tighter liquidity conditions, lower asset values, impaired capital resources, reduced credit supply, and slower aggregate demand feed back on each other,” he says.
New York’s Federal Reserve chief Tim Geithner echoed the words, warning of an “adverse self-reinforcing dynamic”, banker-speak for a downward spiral. The Fed has broken decades of practice by inviting all US depositary banks to its lending window, bringing dodgy mortgage securities as collateral.
Quietly, insiders are perusing an obscure paper by Fed staffers David Small and Jim Clouse. It explores what can be done under the Federal Reserve Act when all else fails.
Section 13 (3) allows the Fed to take emergency action when banks become “unwilling or very reluctant to provide credit”. A vote by five governors can - in “exigent circumstances” - authorise the bank to lend money to anybody, and take upon itself the credit risk. This clause has not been evoked since the Slump.
Yet still the central banks shrink from seriously grasping the rate-cut nettle. Understandably so. They are caught between the Scylla of the debt crunch and the Charybdis of inflation. It is not yet certain which is the more powerful force.
America’s headline CPI screamed to 4.3 per cent in November. This may be a rogue figure, the tail effects of an oil, commodity, and food price spike. If so, the Fed missed its chance months ago to prepare the markets for such a case. It is now stymied.
This has eerie echoes of Japan in late-1990, when inflation rose to 4 per cent on a mini price-surge across Asia. As the Bank of Japan fretted about an inflation scare, the country’s financial system tipped into the abyss.
In theory, Japan had ample ammo to fight a bust. Interest rates were 6 per cent in February 1990. In reality, the country was engulfed by the tsunami of debt deflation quicker than the bank dared to cut rates. In the end, rates fell to zero. Still it was not enough.
When a credit system implodes, it can feed on itself with lightning speed. Current rates in America (4.25 per cent), Britain (5.5 per cent), and the eurozone (4 per cent) have scope to fall a long way, but this may prove less of a panacea than often assumed. The risk is a Japanese denouement across the Anglo-Saxon world and half Europe.
Bernard Connolly, global strategist at Banque AIG, said the Fed and allies had scripted a Greek tragedy by under-pricing credit long ago and seem paralysed as post-bubble chickens now come home to roost. “The central banks are trying to dissociate financial problems from the real economy. They are pushing the world nearer and nearer to the edge of depression. We hope they will eventually be dragged kicking and screaming to do enough, but time is running out,” he said.
Glance at the more or less healthy stock markets in New York, London, and Frankfurt, and you might never know that this debate is raging. Hopes that Middle Eastern and Asian wealth funds will plug every hole lifts spirits.
Glance at the debt markets and you hear a different tale. Not a single junk bond has been issued in Europe since August. Every attempt failed.
Europe’s corporate bond issuance fell 66pc in the third quarter to $396bn (BIS data). Emerging market bonds plummeted 75pc.
“The kind of upheaval observed in the international money markets over the past few months has never been witnessed in history,” says Thomas Jordan, a Swiss central bank governor.
“The sub-prime mortgage crisis hit a vital nerve of the international financial system,” he says.
The market for asset-backed commercial paper - where Europe’s lenders from IKB to the German Doctors and Dentists borrowed through Irish-based “conduits” to play US housing debt - has shrunk for 18 weeks in a row. It has shed $404bn or 36pc. As lenders refuse to roll over credit, banks must take these wrecks back on their books. There lies the rub.
Professor Spencer says capital ratios have fallen far below the 8 per cent minimum under Basel rules. “If they can’t raise capital, they will have to shrink balance sheets,” he said.
Tim Congdon, a banking historian at the London School of Economics, said the rot had seeped through the foundations of British lending.
Average equity capital has fallen to 3.2 per cent (nearer 2.5 per cent sans “goodwill”), compared with 5 per cent seven years ago. “How on earth did the Financial Services Authority let this happen?” he asks.
Worse, changes pushed through by Gordon Brown in 1998 have caused the de facto cash and liquid assets ratio to collapse from post-war levels above 30 per cent to near zero. “Brown hadn’t got a clue what he was doing,” he says.
The risk for Britain - as property buckles - is a twin banking and fiscal squeeze. The UK budget deficit is already 3 per cent of GDP at the peak of the economic cycle, shockingly out of line with its peers. America looks frugal by comparison.
Maastricht rules may force the Government to raise taxes or slash spending into a recession. This way lies crucifixion. The UK current account deficit was 5.7 per cent of GDP in the second quarter, the highest in half a century. Gordon Brown has disarmed us on every front.
In Europe, the ECB has its own distinct headache. Inflation is 3.1 per cent, the highest since monetary union. This is already enough to set off a political storm in Germany. A Dresdner poll found that 71 per cent of German women want the Deutschmark restored.
With Brünhilde fuming about Brot prices, the ECB has to watch its step. Frankfurt cannot easily cut rates to cushion the blow as housing bubbles pop across southern Europe. It must resort to tricks instead. Hence the half trillion gush last week at rates of 70bp below Euribor, a camouflaged move to help Spain.
The ECB’s little secret is that it must never allow a Northern Rock failure in the eurozone because this would expose the reality that there is no EU treasury and no EU lender of last resort behind the system. Would German taxpayers foot the bill for a Spanish bail-out in the way that Kentish men and maids must foot the bill for Newcastle’s Rock? Nobody knows. This is where eurozone solidarity stretches to snapping point. It is why the ECB has showered the system with liquidity from day one of this crisis.
Citigroup, Merrill Lynch, UBS, HSBC and others have stepped forward to reveal their losses. At some point, enough of the dirty linen will be on the line to let markets discern the shape of the debacle. We are not there yet.
Goldman Sachs caused shock last month when it predicted that total crunch losses would reach $500bn, leading to a $2 trillion contraction in lending as bank multiples kick into reverse. This already seems humdrum.
“Our counterparties are telling us that losses may reach $700bn,” says Rob McAdie, head of credit at Barclays Capital. Where will it end? The big banks face a further $200bn of defaults in commercial property. On it goes.
The International Monetary Fund still predicts blistering global growth of 5 per cent next year. If so, markets should roar back to life in January, as though the crunch were but a nightmare. There again, the credit soufflé may be hard to raise a second time.
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seems the problem is real here too ;
well, we don’t hear much of it in the actualities ; but we can see that thee people spent less money for their leasures or cars…
the Euro is surevaluated ; it would be easier if we had still our former currenties, one could devaluate according to the real market ; but it is too late ;
if you have still money to invest, it is said that the asiatic currenties are good, Singapore, China…
December 23rd, 2007 at 1:11 pmWe are DOOMED, I say, DOOMED. Behind the curtain there are a lot of financial entities that have been engaging in what is fraud and now have some heavy subpar securities that they want to shuttle off on the taxpayers, hence they continue to cry doom and gloom to cover their own mistakes!
December 23rd, 2007 at 2:21 pmLet the market take it’s lumps and self correct itself. Keep the B-Rats and Government hands out!
Color me naive, and I always admired Milton Friedman when studying economics but if there is one thing I learned obtaining my worthless MBA, it is this may be an even better harbinger of things to come for us in the U.S.:
http://apnews.myway.com/article/20071223/D8TNBH780.html
I’ve been warning for some time that consumer debt is out of control and many people are living way beyond their means. Did I mention credit card companies are loan sharks?
December 23rd, 2007 at 3:01 pm@Goodbye Natalie
I hear ya … GUILTY, as “charged” (there’s that damn word again).
December 23rd, 2007 at 3:10 pm@drillanwr,
Ah, you wouldn’t make the comments here that you do if you weren’t bright. Everybody gets themselves in a pickle once in a while - just get yourself out of debt quickly, if possible, if that’s where you find yourself.
But I disdain credit card companies because I think they prey mostly on the weak, the desperate, and/or the poor. They’re great if you use them and then pay your bill every month using their money. And the lotteries are worse. No politician ever talks about the hidden cost of gambling addiction. I’m helping a woman now whose husband about gambled their life away. Sad story…
December 23rd, 2007 at 4:02 pmThe stuff on Brown reinforces my opinion: he may be one of the stupidest wankers ever to weasel his way into a leadership position. He has zero hope of actually winning an election.
December 23rd, 2007 at 4:39 pmI’ve been hearing the doom and gloom message preached for 30 years. The dufous economists have been dead wrong for all of those 30 years. Why should I believe them now?
In a free society, where free enterprise rules, economies will prosper and self-correct themselves. This ain’t 1929 or the 19th Century.
They play this shit about every 8 years. Klinton lied in 1994. His data turned out to be completely bogus. His mininions continue to cry wolf. Fook them. None of these so-called experts know shit IMHO.
December 23rd, 2007 at 5:27 pmThis is the kind of sh*t we will see until the election, I bet you will see this echoed by the neo-coms running for president here in the next week. They can’t win on national security so it is the economy stupid.
Read the article it comes full circle on it’s own bullshit:
“The International Monetary Fund still predicts blistering global growth of 5 per cent next year. If so, markets should roar back to life in January, as though the crunch were but a nightmare.”
December 23rd, 2007 at 5:59 pmI saw a presentation by a PHD economist recently, The striking thing to me that he said was ” uncertain times return wealth to its rightful owners”
December 23rd, 2007 at 9:07 pmhttp://www.dailymotion.com/video/x1g8e0_03-ecroulementdesbourses_politics
a video, that says it (in french),
that says if China is rearming (more than 20 % of her budget), it is to conter and digerate their social problems, riots … (that we don’t hear about in the MSM)
and etc… I won’t tell more than you know about your national debt (that, by “dominos” settings, will affect us too)
and a graph there :
http://zfacts.com/p/318.html
in spite of this “rejoicing future”, have a nice Christmas
December 24th, 2007 at 2:55 amWe are in an election year. A year when one candidate, closely aligned with a president whose campaign slogan was “it’s the economy, stupid.” They are using the same formula that got St Bill elected the last time. Much bad press. Many anecdotes and hand wringing to set up the situation where the only solution is change.
December 24th, 2007 at 4:55 amWell, I wondered when a canadate would finally talk about the elephant in the room. Gas prices. It would seem Hillary thinks she could cut oil prices if she were elected. She thinks that her agenda of energy independence would force oil producers to lower their costs. Maybe, but I like the idea of finally becoming independent. Fuck this global economy that her own husband helped put us in with NAFTA and the ilk. I say we charge oil countries $50 a bushel for wheat, $100 for corn. When they don’t pay they can starve. Fuck ‘em.
December 24th, 2007 at 6:38 amI am somewhat mixed in reading this, there has been a lot of positive economic news lately and the MSM just glosses over it and continues to try to talk the economy down. Three good examples, black Friday was 8% higher than last year, which was higher than the year before etc., second example is the spending so far is higher than in 3 1/2, years. I predict that Christmas spending will be considerably higher this year than last. Lastly is the unemployment number, they are still below 5 %.
However I do think there are some negative economic forces at work and I place most of the blame on politicians. Our national debt is atrocious and our infrastructure is sagging. Trillions have been spent on social programs that have done nothing positive. I’m 38 and fairly certain I will not see much in the way of social security. Our electrical energy production is far to dependent on fossil fuels and greenies are still dictating policy on nuclear energy. Infrastructure is where government should be spending money.
Lastly, I think the federal government and greedy dishonest lenders created this credit problem. Greenspan lowered rates a few to many times and lenders began lending money to people who had no business buying homes or at least the ones they bought. People have been living far beyond their means, depending on cheap or crazy credit schemes. I have seen this all too well here in California. And our state in particular is run by a pandering idiot. I think the banks should take in the shorts and let this thing run its course somewhat.
December 24th, 2007 at 6:50 amProf bill, as to the SS ?problem?, we seem to be approaching a tipping point. Tipping? Reaching a point where there will be little or no impact on future benefits.
What did he say?
Yup, little or no impact on future benefits, because the economy has been so strong, and looks to continue, that FICA revenues will cover the cost. If they do need to dip into the SS Trust Fund, then all that will happen is a transfer of ownership of existing bonds from a file drawer to individual ownership. You know those folks who need safe investments for their retirements, probably you. There will be NO INCREASE in over all debt, as those bonds are already counted.
Why do I say this? Because we have a forty year generational problem (baby boomers), and each year we have seen the date extended in which we need to dip into the SS Trust Fund. Currently, 2017, 1/4 through that 40 year problem. So if we can make it through the next decade extending the date when the SS Trust Fund is needed, we will be on the down side of any demand. another decade after that, and there probably will be NO impact.
Stop worrying about SS. GDP growth will trump it.
December 24th, 2007 at 8:14 amSS Trust fund? LOL. There is no SS trust fund. There is no SS lockbox. SS money goes into general revenues. Congress has been borrwing that money for entittlement programs and pork-barrel spending for years. The previous generation has already spent the baby-boomers SS money. What’s left has been spent by Congress.
And we’ve killed off 40 million potential payers into SS thanks to Roe v Wade.
Forget SS. It ain’t there no more.
December 24th, 2007 at 9:00 amThe market will take care of the imbalance caused by people being extended credit that were not qualified to have credit–i.e., subprime mortgages. The banks that issued the credit should take the hit. Any talk of a bail out for the banks or the borrowers is ignorant. Most of the borrowers are not sympathetic figures, and in fact, knew exactly what they were doing when they bought a home using subprime teaser rates, which drove the skyrocketing appreciation of the value of the home, then re-financed, drawing out the equity and living beyond their means on the equity, only to find that their adjustable rates were going up and the value of the home declining below what they had drawn out. Sensible risk is rewarded and greedy pigs get slaughtered.
December 24th, 2007 at 9:20 amYEAH go get um Dan
the only thing I can add to this topic is that rumor has it that
Osama has proposed to Rosie and she is weighing her options.
Have a Jesus filled Christmas.
December 24th, 2007 at 11:09 amDan, cause and effect, “40 million potential payers”. We also wouldn’t have this illegal immigration problem “needed” to take up the slack. Not to mention the financially supplementing their being here.
Can’t remember his name, he’s from India. Supposed to be a financial genius. I think he is a professor at LSU. Wrote, in the early ’90s, a book “The Great Depression (I think of) 1999″. Well, that came and went with Y2K and he reworked the book and changed the date to (also I think) o/a 2002? I think if they can predict the causes they can prevent it. But, then, I’m not a genius.
December 24th, 2007 at 11:30 amDan (The Infidel) you’ve been listening to too many naysayers. The SS TF is there. It is not a 401K. It is a bunch of papers in a file drawer. You’ve been paying interest on them. Or at least the interest has been tracked in the Fed Budget.
I used to believe the same until I did the needed research to understand how it works. As I tried to point out, there is less and less concern amongst those who follow SS that we will even have to cut future benefits. We may not even use the SS TF non-transferable federal bonds.
Lock box? A campaign statement that had no meaning, then and now. All federal trust funds operate the same way. Excess collections are placed in the “General Fund” and non-tranferable bonds written. BTW, the originating SS legislation in 1935 created the process for which it is operating under today.
Merry Xmas to y’all.
December 24th, 2007 at 11:38 am@CoRev:
Don’t think so dude. I’ve been listening to the people running the show. Dream on though…
December 24th, 2007 at 11:41 amFor those who are interested, here’s how SS actually works:
http://article.nationalreview.com/?q=NzYxMWIzMWUxMzFmMGE0OWMwYmQ1YWY4ZDU2NTEyMDc=#more
December 24th, 2007 at 11:48 amJohn, your off as retired, be careful though that your cat ’s food will become out of price as it comes from China
and happy Christmas to you
yeah, Christmas is boring between the dishes
December 24th, 2007 at 1:09 pmIf you’re interested in social security, how it works, and where it stands, here’s the best article I’ve read that anyone can understand.
I’ve got a 401K with Vanguard and have found their “letters” quite good.
https://retirementplans.vanguard.com/VGApp/pe/PubVgiNews?ArticleName=SocialSecurityFuture
December 24th, 2007 at 1:49 pmFranchie, back when this chinese pet food became an issue I had already been feeding my cat the Purina brand. Everything in their product comes from within the US. I wasn’t using it for that purpose but was glad when I found this out after the story broke. Much tighter controls and inspections. Thank God it wasn’t an issue for my cat. Merry Christmas and Happy New Year.
December 24th, 2007 at 5:31 pmDan, what in your old article is different than what I already have said? Most of it was discussing the campaign claims from Gore and Bush. Not the operations of the SS.
Goodbye Natalie, excellent article. I would take issue with this:
What will happen if they are funded with bonds is the current non-tranferable bonds will be converted to Fed Bonds and auctioned to the public. No change in debt, but someone’s pension is then made up of safe treasuries.
Much of what we hear about Fed debt is hyperbolic. Your article is mildly so. No one has to pay. The current Fed debt was initiated in 1861. Yes, we are still paying on the Civil War! It has never been paid off. It has been much higher (as a percentage of GDP.) It may never be paid off. What is paid is the interest on said debt. If that gets to be too high then we can start paying it off, but it actually has not been onerous.
Growth trumps all!
December 24th, 2007 at 6:16 pm