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If there’s a problem with the global economy, no one’s let the world’s stock market investors know.
Markets across the world have been steadily rising as hopes of an end in sight to the credit crunch become more entrenched.
Sub-prime loss announcements are becoming less shocking. Some daring players are even starting to snap up what they think are undervalued assets. Every other day a new distressed debt investment vehicle launches.
The initial earthquake in the financial sector may well be coming to an end. Trouble is, now we’ve got the real world to worry about…
Investors shouldn’t get excited too soon
Another big writedown at insurance giant AIG (NYSE:AIG) hit stock markets on Friday, but overall, investors seem to be growing more confident that the turmoil could be nearing a close.
However, they shouldn’t get excited too soon. Sure, the boys in the City and on Wall Street have become accustomed to hearing about the latest batch of credit losses. Nothing shocks them now. That’s because they now happily believe that the governments of the world won’t allow anything to happen to the financial sector.
The scrabbling of the central banks to bail out Northern Rock, Bear Stearns, and pump as much money as is feasible into the markets, has convinced them of that. So what we have now is a ‘moral hazard’ bounce.
Markets were worried for a while back there that the ‘Greenspan put’ had stopped working (this refers to the belief, nurtured under Federal Chairman Alan Greenspan, that the central bank could and would bail out the US economy whenever recession or even mild slowdown threatened).
But Ben Bernanke, with his utter disregard for the dollar, and cheerful swapping of toxic debt for taxpayers’ money, soon reassured markets that he’d do all he could to save them.
The feeling among some traders now is that no one’s going to go bust in the financial sector – the government will make sure of that. So let’s get out there and snap up some bargains.
The concept of risk was allowed to be forgotten
That all seems quite logical, doesn’t it? Trouble is, there’s a real world out there beyond the financial sector. Where profits are privatised, and losses are nationalised, the concept of risk goes out of the window. If Rolls-Royce could rely on the government to bail it out every time a downturn threatened, then we’d have factories churning out aeroplane parts on every industrial estate in the UK. If you don’t need to plan ahead for the downturn, then you just gouge as much profit as you can during the upturn.
When your financiers are thinking like this, you’ve got problems. Lenders stopped caring about the intelligence or otherwise of the loans they were making. They wanted to suck as much profit out of the boom as possible; the downturn would be someone else’s problem to worry about.
One estate agent quoted in the weekend Telegraph summed it up beautifully. Talking about the housing market, he said “People in the industry have realised for four years that the fundamentals of the market are incorrect. A lot of people have seen it coming, but you’ve got to go with the herd even if the herd is going off the cliff.”
But there’s a little bit more to it than that. The herd may well go over the edge of the cliff – first-time buyers, amateur buy-to-let investors, estate agents. But the ones who started the stampede in the first place, and fuelled it with careless lending – the banks – always knew that someone would be there to catch them. They had become ‘too big to fail’, and so the government and central banks would always have the parachutes ready for the world’s financiers.
And when you’ve got a payment structure in place that means that a salesman (and that’s all most investment banking actually is, glorified sales jobs) only needs one good year to be set up for life, then prudence goes out the window.
How to fix the banking sector
What to do about it? There’s the rub. You have a choice between more regulation, or letting them fail. The trouble with regulation is not that it’s a bad thing, per se. The problem is that regulation is written by an outsider, trying to cover all the bases, all the possible stupid things that a bank could do. Inevitably, they get it wrong. The new rules hamper genuinely good innovation, while encouraging loophole-hunting to find new ways to get away with murder.
The best regulation is self-regulation. But that only works if you stand and fall by your own actions. So if we want an innovative banking sector that also operates responsibly, then we have to let the bad banks go bust. Northern Rock could have gone to the wall without destroying the financial system. It would have caused a significant minority of people a lot of pain, but it was by no means too big to fail.
All of this is academic for the time being. For now the banks are in retreat, licking their wounds, but at the back of their minds is the understanding that they’ll get away with it again in the future. But this time, their carelessness might have gone too far. The real economy has barely begun to feel the squeeze. The US housing market shows no sign of recovery, and the UK one is just embarking on the same downward collapse, which will decimate consumer spending. There are plenty more shocks to come – I wouldn’t call the end of this bear market yet.
Turning to the wider markets…
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The FTSE 100 ended down 66 points at 6,204, as concerns over write-downs at insurance giant American International Group hit financial stocks.
Across the Channel yesterday, the Paris CAC-40 fell 95 points to end the day at 4,960. And in Frankfurt, the DAX-30 fell 68 points to 7,003.
On Wall Street, US stocks fell back as AIG’s woes dented confidence. The Dow Jones fell 120 points to end at 12,745. The broader S&P 500 closed down 9 points, at 1,388, while the tech-heavy Nasdaq shed 5 points to close at 2,445.
In Asia this morning, Japanese stocks made gains; the Nikkei 225 rose 88 points to close at 13,743.
Crude oil was trading at $125.48 in New York. Meanwhile Brent spot was trading at $123.78.
Spot gold was trading at around $880 an ounce this morning, while silver was trading at $16.69. Platinum traded around $2,047.
Turning to forex, sterling was trading at 1.9477 against the dollar, and at 1.2645 against the euro. The dollar was last trading at 0.6496 against the euro and 103.75 against the Japanese yen.
This morning, British Gas owner Centrica has warned that first-half profit will be ‘materially’ lower than last year after high natural gas prices have hurt earnings. The warning came despite a 15% hike in household energy bills in January.
Our recommended article for today…
One share to buy as Britain’s economy follows America’s down
– Many economists agree that the UK economy is mirroring the US – and with its performance just a few quarters behind, the current situation could get worse. But at least the Bank of England has one advantage. Having seen how the Federal Reserve has handled the crisis, it has a better idea of how to avoid a similar blow-up. Martin Denholm presents an American view of the British economy, and reveals one oversold share that could buck the downturn. To read more, click here:
One share to buy as Britain’s economy follows America down