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The Bear necessities

  • 31/03/2008
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The Fed's response to the Bear Stearns crisis gives the Bank of England food for thought about its own progress, says Alan Cleary

The news a couple of weeks ago that Wall Street’s fifth-largest firm had found itself in dire financial trouble sent shock waves around the globe. The fact that an institution of Bear Stearns’s size and prominence could find itself on the wrong side of the credit crunch gave the financial markets plenty to worry about.

Its exposure to bad mortgage debt caused its creditors to recall their funds and the bank was left in a state of illiquid chaos. Thankfully for Bear Stearns, the powers that be in the US Federal Reserve were more decisive in their actions than we in the UK had been during the Northern Rock debacle and managed to pull together a rescue proposal with investment bank JP Morgan during the course of one weekend.

First thing on the Monday, the Fed was able to announce it had developed a strategy that would prevent Bear Stearns from going to the wall. Although the original offer of $2 per share was rejected and replaced with a $10 per share offer, the speed at which the ball was set rolling put the pace of UK proceedings to shame. The Fed also took the opportunity to announce a series of measures designed to help restore liquidity. The government loan facility was extended at a newly discounted rate and the loan period expanded substantially.

However, the actions taken had an unsavoury side effect. That the US government decided to take such drastic action triggered negative sentiment around the world, because it demonstrated how worried the Fed was about the situation. Global share prices consequently slumped. European and Asian stock markets fell heavily, and on 17 March, London’s FTSE 100 closed 3.85% down. In Paris, the Cac 40 slumped 3.2% and in Frankfurt the Dax fell 3.8%.

Global news organisations were poised to report any subsequent rise or dip and speculate on future fluctuations. The reaction seen in the global markets, however, came as no surprise to many industry professionals.

The reality is that in today’s climate, financial firms are playing their cards extremely close to their chests and no one really knows how far exposure to the sub-prime crisis really goes.

The American housing market has now reached bust phase. In February, as rates rose, US home foreclosure filings jumped 60% and bank repossessions more than doubled.

One in every 557 US households found themselves in some stage of default and confidence in the US housing market continued to head south. In light of such events, investors around the globe are waking up to the fact that any degree of capital they have tied up in financial commodities is at risk. Without a categorical understanding of their exposure to the US market, they are effectively fire-fighting.

Global concern

Unfortunately, it is not only the US housing market that is facing a crisis of confidence. The situation in the UK shows real signs of slipping dangerously close to the edge. The reluctance on the part of global investors to put their faith in mortgage-backed securities has left UK mortgage lenders with severe funding difficulties, too. Providers across the board have had to readjust their volumes and limit their lending parameters.

Consequently, certain sectors of the market have disappeared, and it has been estimated gross lending volumes could contract by as much as £110bn.

This likelihood of a substantial shortfall in mortgage lending is undisputed and it is widely agreed this could lead to severe stagnation in the housing market.

For the average consumer, there is already increased pressure on pay packets. Rising council tax, extortionate fuel prices and increasing food costs are set to squeeze disposable incomes. Oil prices are five to 10 times higher than in the late 1990s; corn is up 130% in the past five years and copper has soared 460% in the same period. For some consumers, rising mortgage costs could be the final nail in the coffin, and there is an increased possibility of rising defaults and repossessions.

Opaque investment vehicles are not exclusive to the US, and companies based in the UK have their fair share of unidentified exposure.

It is unsurprising, therefore, that the Bear Stearns crisis had an acute impact on the FTSE 100. The fear of a stagnant housing market, rising repossession levels and the potential exposure to bad mortgage debt has naturally affected the share value of many financial institutions, yet finance stocks are not alone. The squeeze on disposable incomes will prevent people splashing out on the nice-to-haves, and as a result, the prospects for retail look uncertain. Share prices in all business sectors face a turbulent period.

However, despite this, there are no obvious signs the Bank of England is taking sufficient steps to rectify the situation.

Admittedly, the Government pledged £15bn to address liquidity issues in the short-term money markets, but is this enough?

The liquidity crisis shows no sign of recovery and the spread between Libor and the Bank base rate has once again started to increase. Since last September, the Fed has cut interest rates by 3%; by comparison the UK base rate has fallen only 0.5%.

Whether or not the Fed’s actions will prove successful is anyone’s guess, but at least it has taken decisive steps.

The meeting between BoE Governor Mervyn King and the bosses of the UK’s big banks seems not to have resulted in any concrete measures.

However, the Bank’s website states it has agreed to continue its dialogue with the banks. Let us hope the banks are able to convince Mr King that more must be done to protect the future of our financial system – and fast. n

Alan Cleary is managing director of Edeus

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