When central bankers and finance ministers gathered last month at a luxury
golf resort at Kleinmond, some 70 miles from Cape Town, they could have been
forgiven for thinking they were heading for a welcome break in the sunshine.
Known for the wild horses that roam in the surrounding marshlands and as an
ideal spot to watch whales from the shore, Kleinmond was a world away from
the problems policymakers like Bank of England governor Mervyn King and
Alistair Darling, the chancellor, were grappling with at home.
But the mood at the G20 meeting was dark. The global credit crisis may have
had its origins in America’s sub-prime mortgage market but its tentacles
were spreading throughout the global economy.
The crisis came to the surface in August, and at the annual gathering of the
International Monetary Fund in Washington in October there was a feeling
that the worst might be over – but such hopes were dashed.
“There was a sharp change in mood,” said one of those present in Cape Town.
“Everybody could see that things had deteriorated.”
The G20 – attended by finance ministers and central bank chiefs of the big
industrial countries (America, Japan, Germany, Britain, France, Italy and
Canada) but also by Australia, Brazil, China, India, Indonesia, Mexico,
Russia, Saudi Arabia, South Africa, South Korea, Turkey and the European
Union – is fairly new on the scene, having first met only eight years ago.
Unlike the G5 and G7, which came to prominence with their efforts to manage
currencies in the 1980s, the G20’s deliberations are not closely monitored
in the financial markets.
But the seeds of last week’s audacious plan by leading central banks to head
off a fully-fledged credit crunch and global recession were sown in
Kleinmond, and the communi-que released at the end of the meeting gave a
clue.
It referred to the “immediate policy priority” of “restoring and maintaining
orderly conditions in financial markets”. It also “noted that downside risks
to the near-term outlook have increased as a consequence of recent financial
market disturbances”.
Ten days ago, a series of secret calls took place between the world’s leading
central banks. Ben Bernanke, chairman of America’s Federal Reserve, and King
at the Bank of England were said to be instrumental in driving the action
plan forward. Their market specialists then worked out the fine details.
There was little hint of it, however, on Tuesday, when the Fed announced a cut
in the key US Fed Funds rate from 4.5% to 4.25%. While the cut was expected
by most economists, it disappointed markets that had hoped for a reduction
of half a percentage point in both the Fed Funds and discount rates.
“The Fed has erred dangerously on the side of caution again,” said Bernard
Connolly of Banque AIG. Shares in New York slumped, the Dow Jones industrial
average falling by 294 points.
The very next day, however, the mood was reversed, if only temporarily, with a
joint announcement from the world’s leading central banks of the plan they
had begun to hatch at the G20.
Disappointment turned, at least briefly, to elation, accompanied by irritation
that the Fed had not set out its intentions when it announced the rate cut.
In old Hollywood movies, the cavalry arrives in the nick of time to prevent a
massacre. Last week’s announcement was the equivalent of the central-bank
cavalry arriving to head off a massacre in the money markets.
The joint operation, by the Fed, the Bank of England, the European Central
Bank, the Swiss National Bank and the Bank of Canada, was both an admission
by them of the seri-ousness of the situation and an attempt to do something
about it, “to address elevated pressures in short-term funding markets”.
So the Fed announced a new “term auction” facility, allowing banks to borrow
$20 billion (£9.9 billion) for a month at each of two auctions on December
17 and 20, with two more auctions to follow in January.
The Bank announced that on December 18 and January 15, it would increase the
amount it was prepared to provide to the market from £2.85 billion to £11.35
billion, with £10 billion of this available for a three-month period. The
Bank also widened the list of collateral it was prepared to accept against
these loans, something the banks have pushed for, and announced that the new
funding would be available, not at a penalty rate, but at a rate determined
by demand for the funds.
The other central banks announced similar moves, while those of Japan and
Sweden said they were ready to act.
For the Bank governor – who has made his unhappiness with the commercial banks
clear since the credit crisis broke in August – this was a big moment.
Having argued that there were serious “moral hazard” objections to bailing out
irresponsible banks, he needed last week’s announcement, which may have the
effect of doing that, to be part of an international operation for the
greater good of the global economy.
But was the action of the central banks enough to stem the crisis? Or will
last week’s move to prevent it spreading turn out to be just sticking
plaster on a much deeper wound? UNTIL a few weeks ago, only those closely
involved with the money markets paid much attention to so-called interbank
rates, the rates at which banks lend to each other.
Now what happens to these rates has become not only a barometer for the
pressure in the banking system but also crucially important for business and
consumer borrowers throughout Britain.
When the credit crisis broke in the summer, three-month Libor – the London
interbank offered rate – rose to nearly 7%. Before last week’s action Libor
appeared to be heading that way again, rising to more than 6.6%, more than a
percentage point above Bank rate, 5.5%. One-month Libor was even higher, at
6.75%, partly reflecting end-year funding pressures.
The announcement by central banks succeeded in bringing the rates down –
three-month Libor was fixed on Friday at 6.5%. But rates remain far higher
than normal, implying a significant squeeze on the economy.
“These emergency money-market measures have only produced a slight thaw in
money and credit markets,” said Michael Saunders, an economist at Citigroup.
“Moreover, these measures do not remove the prospect that the economy will
slow sharply because of the drag from severe housing weakness, high
household debts, the past year’s rate hikes and the recent marked tightening
of credit availability.”
Overhanging any return to normality, say analysts, is the news coming out of
the banks as they reveal the scale of their writedowns.
UBS, the Swiss banking giant, added to the worries about the extent of
sub-prime losses by announcing a further $10 billion of writedowns, on top
of the $1.6 billion it announced in the third quarter. Having admitted to
just over $20 billion of such debt, the move meant that UBS has now written
off more than half.
The bank reassured the markets by announcing a capital-raising package, much
of it from the Singapore government’s sovereign wealth fund, but the banking
jitters remained.
HBOS has limited exposure to American sub-prime problems – it announced a
write-down of only £30m when it unveiled its second-half results.
Nevertheless, its shares suffered a torrid week because higher funding costs
in the money markets will squeeze its margins. Worries about Britain’s
housing market only added to the fears.
Tim Congdon, the monetarist economist, in a new report for the Economic
Research Council, Playing With Monetary Fire, warns of a sharp reduction in
the availability of credit next year, in spite of the action by the central
banks.
In the year to September 2007 net new lending by UK banks and building
societies amounted to £240 billion, with mortgages accounting for almost
half the total. In 2008 new lending is likely to be under £150 billion, he
predicts, with mortgage finance being two-thirds or less of the 2007 figure.
Officials insist that last week’s moves were never intended to end the crisis
at a stroke, and never could have done. It was crucial, said one, “to
provide an important signal” about the intentions of the central banks.
There’s no magic bullet here”.
The crisis, they concede, will drag on until well into next year, and
additional moves of the kind announced last week will be taken when needed.
“It will be difficult for central banks to admit defeat so I assume that they
will take further action – a mix of base-rate cuts and flooding the
interbank market with liquidity, until they have prevented any further risk
of recession,” said Douglas McWilliams, director of the Centre for Economics
and Business Research.
“It is too late to forestall a slowdown but a recession probably can be
prevented. But interest rates may go at least as far as the markets are
currently predicting – down to 3.5% in America and 4.5% in Britain – and
possibly further, especially in Britain.”
While the gloom appears all-enveloping, and the central banks by taking their
unusual action have underlined how seriously they regard the situation, some
see silver linings.
Calyon, the investment-bank-ing arm of Crédit Agricole, the French bank, heads
its 2008 outlook “Don’t assume the worst”. Growth in the advanced economies
“bends but does not break”, it said. “While it is hard to argue for any
upside surprise, it is also difficult to see a chain of events that leads to
recession.”
Jim O’Neill, head of global economics research at the Goldman Sachs investment
bank, goes further. “Given the mood of markets since the rapid esca-lation
of the US sub-prime crisis, and their subsequent credit problems, we think
there are as many, if not more, possible positive surprises as negative
ones,” he said.
These surprises could include a stronger dollar, an early halt to the weakness
in the American housing market and robust spending by American and European
consumers, he suggested.
Even so, while any or all of these might argue for a short-lived downturn, few
doubt that a period of weakness is coming.
When the G20 met in South Africa last month, one source of comfort was that,
while growth prospects in the advanced economies were being hit by the
credit crisis, the emerging markets, led by China and India, were sailing on
regardless.
That, however, may not last, according to a new assessment by the Standard
Chartered bank. It thinks a downturn in global investment will chip away at
China’s sky-high growth, 11% at present, reducing it to 9.5% next year and
8.2% in 2009.
“While policymakers in Bei-jing currently worry about overheating at home and
are busy coming up with measures to cool things down, the medium term looks
increasingly likely to present them with a much more difficult challenge: a
slowdown in China’s biggest source of demand,” said Stephen Green, Standard
Chartered’s China economist.
“We think there is a rising risk of China getting hit harder than the
consensus currently assumes,” he said.
For many countries, even these slower growth rates in prospect in China remain
a source of wonderment. But when even China is being affected, the inference
is clear: the consequences of the credit crisis have much further to run.
The central-bank cavalry may have arrived but the battle is far from won.
BANKERS FEAR FOR BONUSES
THERE’S been an unseasonally sombre feel in London’s bars where the office
Christmas parties have lacked gusto.
Bonuses are on everyone’s minds but, particularly compared with the bonanza of
last year, most investment-bank workers are not feeling merry.
This year bonuses are expected to be down by as much as 50% at investment
banks whose balance sheets have been torpedoed by losses mainly from the
American sub-prime mortgage fall-out and which are still suffering from the
credit crunch.
There is a mutinous air in some banks, especially in Europe, where many have
had a record-breaking year.
The credit crunch may have dominated the summer, but, before and after, two of
the biggest ever deals broke: the fight for ABN Amro and then BHP Billiton’s
£80 billion bid for Rio Tinto.
These alone created blockbuster financing deals – for instance, the €13.4
billion (£9.5 billion) rights issue by Fortis bank to pay for its part of
ABN Amro. The deal has propelled Merrill Lynch, which organised the issue,
to the top of the equity capital markets league table.
There were other deals, too, as companies swooped to take advantage of the
paralysis in the private-equity sector.
The banks’ bosses are all too aware of the need to pay their stars or risk
losing them. But many bankers, including the best, have been warned to
expect a large proportion of their bonuses in shares. Insiders at Citi, UBS
and Merrill Lynch say they expect at least two-thirds of their bonus in
stock.
“We always get a slug of shares but not this much,” said one banker. “You
can’t buy a house with shares.”
There’s one notable exception – Goldman Sachs, which, compared with
its peers, has sailed through the crisis with little damage.
