“Every sensible person should be at the beach today,” as one depressed fund manager put it. Fear returned to the markets this week as it became increasingly clear that the year-long credit crunch is nowhere near over. A jump in US producer prices to a 27-year high provided a reminder that inflation is not likely to fade away quickly, even though commodity prices are now falling. Meanwhile, the shaky financial system was back in focus as shares in the giant US mortgage lenders Fannie Mae and Freddie Mac resumed their recent slide.
These key providers of liquidity to the US mortgage market “continue to bleed mortgage losses” as defaults have spread beyond the sub-prime sector, noted The Wall Street Journal. As they are too big to fail, speculation over a government bail-out to recapitalise them is mounting, and this is likely to see shareholders wiped out. Meanwhile, former IMF chief economist Ken Rogoff further rattled investors when he warned that the credit crisis was only half over: “America was not out of the woods… the worst [of the financial crisis] is yet to come.” What’s more, bankruptcies won’t be confined to mid-sized banks – “we’re going to see a big one” collapse in the next few months.
A new phase of the credit crisis…
There’s certainly no sign of an end to the crisis. Money market rates have risen again as banks remain reluctant to lend to each other, while David Rosenberg of Merrill Lynch notes that despite the Fed’s rate cuts, the average interest rate in the US private sector is still 6.8% – last September’s level. The latest surveys of lenders in both Europe and the US point to tightening lending standards.
And now a “new phase” of the crunch is in the offing, said David Prosser in The Independent. First came major losses on mortgage-backed securities, and now banks are facing “a much more conventional source of write-offs – mounting bad debts” as economies worsen. With unemployment rising and house prices falling in both Britain and America, more and more households will fall behind on servicing their record debt burden. That bodes ill for banks, consumption and hence growth.
…leading to a vicious cycle
Bridgewater Associates recently estimated that total worldwide losses from the credit crunch will hit $1.6bn (so far around $500bn has been written off) with non sub-prime housing loans and corporate loans delivering hefty blows. So ailing banks are set to tighten lending further as losses pile up, raising the spectre of a “negative feedback loop” whereby tighter lending hampers growth and prompts banks to restrict lending further as the economy deteriorates. Given the grim outlook, it’s no wonder fund manager Jeremy Grantham last year described the credit crisis as a “slow-motion train wreck”.