The US authorities try to pilot through the Credit Crunch storm

The failure of Lehman surprised the markets more than it should have, and left many investors nervous about bank shares and much else.

It followed hard on the heels of the nationalisation of Freddie and Fannie, and should be seen as part of the US Treasury Secretary’s strategy to get the western economies and the banking system through the troubles of the credit bubble.

The US authorities have always been sharper and more realistic about the aftermath of the bubble than the other jurisdictions of the world. They were the first to cut interest rates, the first to lend big money to ailing institutions and the first to use a tax cutting package to stimulate demand.

Many see this as primarily a US problem, with its origins in the US housing market and the sub prime crisis. It is true that the US has a big and bad version of the problem, true that the US has many of the largest financial companies that did well out of the credit boom, and was the first into the downturn. The reason markets fell around the world, is the realisation that this is not just a US problem, but a global one.

Big banks from the EU and Asia as well as the USA increased their lending and ballooned their activities in a similar way. Bankers around the world lent money to people who will find it difficult to repay in these more hostile conditions – for residential homes in Spain and the UK, for highly indebted businesses the world over, for expensively valued commercial property in a variety of jurisdictions. Banks worldwide bought as well as sold the new highly leveraged products of the Credit Boom era. When one of the big players like Lehman goes down, there are understandable fears about losses around the world from banks and financial companies trading with them, who also own similar pieces of paper to Lehman.

The Treasury Secretary seems to have decided that he will use the huge resources of the US taxpayer to stabilise the US front line large banks serving the general public, and to try to breathe some life into the mortgage market. He has rightly decided that even the long pocket of Uncle Sam cannot credibly underpin the whole shaky edifice of post bubble finance. He has concluded that it is safe to let a large financial institution like Lehmans file for bankruptcy protection, speeding up the revaluation of the complex financial instruments that made its fortune on the way up and proved its ruin on the way down. He understands that a lot of wealth has been destroyed and the system has to adjust to that. He is trying to work out which institutions are too important to the system to be allowed to go under. He shows a certain political understanding in an election year that using taxpayers money to put some floor under US house prices is the best combination of political shrewdness and help to the overall banking system.

Will it work? Let’s hope so. The Treasury Secretary is the most important person in the economic and financial world today. The Fed is taking a backseat, and the President is delegating it to an old wall Street pro. The other governments and Central Banks are bystanders, watching as the world’s biggest economy throws its might behind some of the shaky parts of the financial structure, and allows controlled demolition of other parts. It is the best strategy we have got, and we are not in a position to force another one. It would be wrong to let everything shaky collapse at the same time, and folly to suppose the US taxpayer can prop everything up as if nothing had happened. It does look as if the US are aware of the dangers, the complexities and the size of the task. It is clear they are learning on the job and are prepared to be flexible, as no-one has been here before. This crisis is on a different scale to other credit bubbles post 1945. We will find out in the days ahead if the line between institutions to be saved and institutions to be left to their own devices has been drawn sensibly. It is a line which may be redrawn by events.

Amongst the politicians it is popular to blame greedy bankers. Jealousy is a powerful political emotion. The fabulous incomes of some “bankers” in recent years is an easy target. No doubt we could all point to a few greedy bankers or dealers, just as no doubt there are a few greedy footballers. What really annoys people who watch the gyrations of the markets from afar is just how much money the system allowed its practitioners to make, only to discover that the business they were doing was not stable. The politicians on both sides of the Atlantic will blame the bankers and then demand more or different regulation, not pausing to reflect on the irony that this was the most regulated of industries, where many of the schemes and money making practises were devised to stay within the complex rules the regulators had imposed.
Mc Cain and Obama are united once again, this time in condemning Wall Street and its excesses, and demanding unspecified changes to the regulatory structure. They both must be hoping that the Bush men have bottomed this crisis by the end of the year.

The mood seems to be inclining to require a return to “traditional” banking, where more of the advances made stay on the balance sheet of the bank making the loan. This will reduce the total amount of credit that can be extended, and cut out the employment of many of those who made a great living out of creating , trading and investing in packages of loans made by the banks. Allowing Lehman to go under implies the authorities do not value the clever work of the intermediaries and professional market makers. When it comes to lending people a mortgage, they do want to stand behind Fannie and Freddie and help them in the short term make more loans available to customers.

This distinction seems popular and fair until you look a little more closely at it. On both sides of the Atlantic many more people got mortgages only because there were clever intermediaries and professional traders prepared to package loans and take them off the books of a Northern Rock or a Freddie and Fannie. If some or all of this comes to an end there will be further falls in house prices, which in turn undermines the favoured banks as well as the smart dealers and intermediaries. It is all more joined up and complex than some reformers would like.

The US authorities could also cut interest rates. Rates in the market have shot up as banks and others react badly to the news of real risk in lending and trading with other financial institutions. This would be a good moment to cut the Fed rate. There is no danger of inflation taking off or of too much credit in this environment!


  1. mikestallard
    September 16, 2008

    On Newsnight last night, the experts were of the opinion that we are, in fact, facing the 1930s all over again.
    Then there was a simple cause: protectionism and over production coupled to the destruction of the environment in the West (John Steinbeck).
    I am not at all sure, myself, why the USA and UK are so rich in the world. We don't seem to make much stuff any more (rust belt?). We don't seem, to be the kings of the carrying trade either.
    Perhaps it is our education systems?

    Reply: The UK has been relatively successful in recent years thanks to its success at financial and busienss services.

  2. Johnny Norfolk
    September 16, 2008

    Perhaps the Labour government should set an example of showing what is what on the nations balance sheet

  3. Acorn
    September 16, 2008

    I understand from US contacts that the FED is concerned about a crash in US Treasury Bond prices which lead to not bailing out an "investment" bank, as apposed to a "retail" bank. Also, Bear Stearns had a large "back office" which handled clearing for many other finance houses. Shutting down BS would have caused chaos across the whole system.

    You may wish to see the following:-

    Then click on the "Fridays commentary" [first para] and have a read of the "Recent Analysis of the Credit Crisis" articles at the end of the article.

  4. David Eyles
    September 16, 2008

    I've just seen a short tape on the Telegraph business where a banker is blaming …… greedy bankers for the currrent crisis. Hmmmm.

    But, as you say, the world is much more complex than the regulators know. One of the side effects of too much cash in the City has been that agricultural land prices have been much too high for far too long because wealthy city types have been buying into "lifestyle" farms. The situation has been exacerbated by IHT rules that allow agricultural land to be exempt from IHT. The consequence of this is that many of us who really want to farm to produce food and work on the land have to compete by paying prices for land which is far higher than its intrinsic value in producing food would allow.

    However, simple removal of this IHT provision to stop wealthy people using agricultural land as a tax break will also disinherit many existing farmers and penalise those of us who plough much of our other income into the the farm to invest in its future. Perhaps some of the problem would be removed by removing IHT altogether.

    Another side effect of the overly wealthy bankers has been the reluctance of our brightest young people to engage in subjects like science and engineering, because a degree in economics makes a very large income so much easier to obtain. Our long term mixed economy of trading and manufacture has been compromised as a result.

  5. figurewizard
    September 16, 2008

    The reason that Fannie Mae and Freddie Mac were rescued by the US government was because they are Government Sponsored Enterprises (GSEs), whose charters (granted by Congress) specifically required them to fund mortgages to people on low incomes at rates that would have been below those on offer from commercial lenders had they been foolish enough to get involved. They would then provide the cash to mortgage providers who would retain part of repayments as a management fee, while the rest of the cash was remitted to them. They in turn would then pass on the cash to those banks who had purchased blocks of their mortgages thus provided by way of MBSs (Mortgage Backed Securities). It was the devaluation of these securities, resulting from defaults by borrowers that kicked off the collapse in confidence that has led to the credit crunch and the collapse of the likes of Lehman Bros and doubtless others to come. The blame for this therefore lies four square at the door of the US government by implicitly underwriting vast amounts of money invested in assets that defied commercial commonsense thereby distorting the market for securities. This should be a salutary lesson for those calling for more government support here for the housing market, whether through interest rates or anything else. Any device that smacks of socialism, as in Fannie Mae and Freddie Mac can only lead to yet further disaster.

  6. Eddie Allen
    September 16, 2008

    The Free Market and Globalisation doesn't work and it's all complete nonsense. The world is being conned with it.
    When you have supermarkets selling insurance and mortgages, and insurers selling and buying each other and mortgage companies struggling to compete to loan money instead of taking prudent risks with an observed experience, it's time to call a halt to it.

    Meanwhile, the most dangerous man in the world peddles a policy I doubt he understands himself.

    This is the most dangerous policy in the world and he's not accountable to a single authority for his actions.

    "Globalisation is across party divide and throwing cultures and countries together and this is one of the issues I'll explore in the faith and globalisation course which I'm starting with Yale University later this year" Tony Blair 2008

    The UK needs to get a grip of this before it's too late.

  7. lucysharp
    September 16, 2008

    "On both sides of the Atlantic many more people got mortgages only because there were clever intermediaries and professional traders prepared to package loans and take them off the books of a Northern Rock or a Freddie and Fannie".

    Is getting a mortgage that wouldn't be offered by any prudent lender really such a good thing? I'm not unsympathetic to people who succumbed to the temptation of borrowing five or more times their optimistically self-certified incomes at attractive introductory rates, not least because I nearly did the same thing myself, but honestly, where did they think the money was coming from in the long run? I don't think it is unreasonable to be expected to provide a substantial (at least 10%) deposit and have a reliable savings history. If people can't do that then perhaps renting for a few years would be the wiser option. It is still just possible to lead a worthwhile life without being a homeowner.

  8. Bazman
    September 16, 2008

    City boys. Welcome to the real world. Have you noticed how bad the cutlery is getting in first class.

  9. Bazman
    September 17, 2008

    There will always political and financial capital to be made from cheap money (mortgages?) Everyone wants to own their own home and control their own destiny. Escape the Landlord or boss at any price. (Risk?) It's not just about money. It's much more than that.

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