Maybe it's the thought that it's straight after the end of the holiday season. The realisation sets in that the next real break from it all is still over 3 months away. Maybe this then leads to an early onset of the "winter blues" and a fear of armageddon as the days draw ever shorter and the weather ever colder. Then every now and again this end of days fear results in an end of days moment. Whatever the reason may be, September and October have proved to be the dark days through history for the economy and the markets, the time when everything seems to just come to a head.
- September 18th 1873 - Black Thursday - triggering the panic of 1873
- The Panic of 1907 reached a climax in October.
- October 24th 1927 - Black Thursday - and October 29th 1927 - Black Tuesday - saw the great Wall Street crash and the onset of the depression.
- October 19th 1987 - Black Monday - when global markets collapsed and the Dow Jones fell over 22% in one day.
- 16th September 1992 - Black Wednesday - when an attack on sterling by speculators forced it to withdraw from the ERM.
- 15th September 2008 - Lehman Brothers declares bankruptcy causing global market panic and the onset of the Great Recession.
The most recent of those days is approaching it's 5th anniversary on Sunday and we are still scrabbling around hoping we are moving beyond the green shoots of recovery to a more stable global economy. As many commentators have written, that fateful day in September was not the cause of the current financial crisis, but it pushed it over the edge as the fear that gripped threatened to collapse the whole financial system and with it the world as we knew it.
Even in hindsight that moment was not inevitable for those on the outside or the inside of the firm. The moral hazard had been set by the Fed assisted bailout of Bear Sterns by JP Morgan and the government bailout of Fannie Mae and Freddie Mac as well as others. The market anticipated the same result for Lehman even as it sent its share price plummeting ever faster towards zero. Even on the Friday before there was seemingly a knowledge for those of us inside the firm that we would still be walking through the same doors on Monday morning, it was just very likely we'd be working for new masters. Barclays and Bank of America we were told were the suitors and one of those was likely to take over by the end of the weekend. The Fed was calling all the heads of the major banks together to work through a solution which would save the company from bankruptcy in a way which would prevent an outright collapse in the markets. This had happened before when the behemoths of the financial world had got together and worked to ensure the world kept turning. In 1907 the eponymous banker JP Morgan had locked all the chief financiers of the time in a room until they came to a solution to bailout the Trust Company of America. In 1998, as the hedge fund Long Term Capital Management tinkered on the brink of collapse, threatening to drag others with it, a similar plan was drawn up for all the major banks at the time to cough up the money to stave off the $3.625bn collapse (intriguingly also in September!).
This time however it was not to be. No agreement could be reached in a weekend as to how to save the firm or how to unwind it in an orderly fashion. Bank of America went to Merrill Lynch's rescue, stepping in before they could become the obvious next victims, whilst Barclays (whether stopped or not by the FSA at the time) decided against buying the firm and instead picked up the New York side of the franchise post bankruptcy, the piece they most desired. Lehman Brothers was thus left to file for the largest bankruptcy in history ($681bn if you're interested, 5 times that of Worldcom the previous largest) sending the financial world into chaos as the house of cards began to collapse across the globe. Governments were forced to act to stop the rot immediately and ended up acting to save the majority of financial institutions through the very bailouts they sought to avoid giving to Lehman Brothers. The markets plunged all around and the supply of credit ground to a halt as every institution was afraid to lend fearing their counterparty was next to fall. (As for me and the rest of the Lehman employees on that Monday morning, we were left to scratch our heads (or mostly hold head in hands) walking out the building with boxes of belongings (whose belongings in some cases is questionable!) wondering where we would go to next. Some of us got lucky while others didn't. But I'll save you the personal stories and recollections for a later age when I feel fit to write my memoirs.).
Now that we're 5 years on from that headline event of the financial crisis, the question on everyone's lips is could it happen again or are we doing enough to stop it.
For the majority of the populations of the countries affected there is a feeling of animosity towards the banking industry as governments from the UK, Iceland, Ireland, the US and many many others were forced to pump trillions of dollars (that's thousands of billions) into the banking industry preventing it's collapse. There's no doubt in my mind that the actions of both governments and central banks were necessary to avoid the world hurtling towards another great depression. That these actions themselves may have created a moral hazard for the future remains a fear.
The banks themselves still remain leveraged to a degree which, in the result of a similar withdrawal of funds from the bank due to some panic, whether by retail depositors or the withdrawal of short term funding (as was the case for Lehman and Bear Sterns), would still leave them needing rescue either by peers or the government. Lehman was leveraged at it's peak by 44 to 1 (Goldman and Morgan Stanley at the time had ratios in the 20s or 30s). Whilst now Morgan Stanley is estimated to be leveraged 14-1, a drastic reduction, a similar sudden shock for them would leave them desperately scrabbling around for further capital. They are not alone in this respect. Under banking regulations known as Basel III, proposals have been drawn up for banks to increase the amount of assets they hold and the strengthen the quality of those assets, but it will take several years for many banks to get to those levels and it's effects, at least in the short to medium term, may serve to curtail bank lending at a time when the economy would benefit from increased lending. Barclays, for example, recently announced rights and convertible bond issuances to help raise £8bn of the £13.8bn pounds they require to get to the required levels, as well as talking about reducing its balance sheet.
What about one of the other major causes - the use of certain derivatives and their inter-connectivity in the market? Even here global regulators are struggling to come up with robust rules to try and ensure there is enough regulation and tracking of these products that it is easier to ascertain who holds what, where they hold it and, if the music again stops, which firms are going to be left with the toxic time bomb this time. Each region has been working hard to draw up their own rules and try and make them as coherent as possible. The Dodd-Frank Act passed in the US has tried to ensure all derivative transactions are centrally reported on the day of transaction, whilst also seeking to settle more and more OTC derivatives, such as Credit Default Swaps, through centralised clearing houses. The idea with these requirements is to increase the transparency of trading in these products and to reduce counterparty risks by having them settled through a central area where netting can be carried out if needs be in the case of disaster. The European Market Infrastructure Regulation (EMIR) seeks to implement a similar exercise in Europe. Both these pieces of legislature go some ways to improving the risks imposed by certain forms of derivatives, but there still remains doubt as to whether this will prevent issues caused by the more complex financial products similar to those which played a part in the crisis. Financial innovation has and will continue to play a part, and in most cases an important part, in providing new ways of financing and hedging for companies and banks alike. Some of these will seek to find a legal way around tax, accounting or other regulations. The relevant authorities, be it the PRA in the UK, CFTC or SEC in the US or the EU bodies, will need to ensure that they keep apace with developments in the market to seek to understand the products as and when they evolve. They will need to act to amend legislation at the time the products are in their infancy to ensure future risks are mitigated long before they happen.
The banks themselves of course having been bitten so badly and left with so many bad debts are also ensuring, for now, that those they lend to will on, the whole, have the ability to pay it back. The idea of lending money to someone with no income, no job or Assets (NINJA) is at this time a thing of the past and one which banks are unlikely to want to take up again in a hurry. Meanwhile discussions continue apace globally about what further measures to put in place to ensure banks don't end up in a similar situation again.
It is a slow process, but gradually the pieces are coming together to help reduce the likelihood of the same mistakes being made again. Therein however in the solution and the potential solutions lie the answer about whether this could happen again. The authorities can look back at the last crisis and its causes and devise many ways in which to mitigate it happening in the future, but it is very hard to put in place laws which will restrict the next crisis from happening when, as Donald Rumsfeld might put it, it is likely to be an unknown unknown which triggers it. One of the main factors in the cause of the crisis which is very difficult to mitigate against in the future is the one which links many of those affected and involved in the crisis, that of greed. Greed is a human trait which has become more and more prevalent in human society in the 20th and 21st centuries, the need to want more. Whether it was in the banks seeking to sell more and more products to inflate profits and bonuses, or the man in the street seeking to borrow money they couldn't afford to buy a bigger house or car, the wish for more of the good things in life even when it should be beyond our reach is ultimately what pushes things over the edge. The truth is if the roles of the 2 examples before were reversed both would still act in a similar vein, it's unfortunately part of most of our natures.
This crisis and the housing bubble in it's lead up were no different in that respect to any of the previous bubbles. Whether it was the dotcom bubble, the tulip bubble of the 17th century or the recent property bubbles, bubbles form because people see an asset rising steadily in value and they want a piece of the action and get "their share" of the profit. The issue with a bubble is that most can't see it ending before it bursts and as a result plenty get burnt. This time the fire was hotter and more people got burnt as a result. The consequences of the 1929 crash and the depression remained etched in the memory for decades precisely because the repercussions were so immensely bad. The solutions put in place at that time eventually did the best to ensure the same wouldn't happen again, although it took a long time to find the right solutions. After a long lapse though inevitably more bubbles came and went, even if not to the same extent, as the memories faded and the exuberance returned.
The response and speed of response to the current crisis have meant, so far, we've not been faced with another great depression. As markets already look to have bounced back, and house prices rise again, the fear becomes that it won't take long to forget the excesses of 5 years ago and the bubbles will return, spurred on by the greed of those that have already forgotten. It won't be the same as before, it rarely is, and we can hope that the remedies put in place this time can stave off a similar size of crisis for the foreseeable future. Eventually though, memories will fade of the consequences of the past and there will be further boom followed by just as great bust. That is capitalism I'm afraid and all that can be done is to try to soften the blows that arrive, preferably before they arrive. But even when it does happen again, we still may never know for certain why the darkest financial days seem to occur as the sun itself begins to fade.
No comments:
Post a Comment