Be afraid, be very afraid - this baby's gonna blow. Monday, March 17, 2008
In Hollywood catastrophe movies, it's often only the heroes that are privy to the news that the earth is about to explode or that a new ice age is starting tomorrow.
The banking crisis is headline news and whilst the earth isn't going to explode, economic conditions are rapidly worsening. Banks are refusing to lend to each other, even overnight, at the moment and central banks are becoming pivotal players in the markets, almost acting as central counterparty in an effort to dampen the havoc.
Do most people understand the gravity of the situation - I doubt it and for understandable reasons. After all, to most people the banking system somehow just works and provided you can get a mortgage and use your ATM card, what else is there to know? Sadly, the fear in the banking community is going to hit everyone. Here's some examples of how
- Mortgages. These are considered toxic by banks, concerned about failing house prices undermining the collateral values they have. Consequently, banks are withdrawing from making offers. This is going to hit anyone looking for a mortgage or to re-finance their existing one. It will both reduce the spending power and number of buyers in the market, thereby creating even more downward pressure on housess. Additionally, it will result in increased mortgage payments which will erode disposal incomes and make people feel much worse off.
- Jobs. The UK finance sector employs about 20% of workers according the Wall Street Journal. These tend to be better paid jobs. Reduced bonuses and job losses will hit confidence and spending in the economy. Direct and indirect tax revenues will suffer, further limiting the Government's ability to "invest/spend".
- Commodities. Investors are trying to find "safe havens" and despite an anticipated slowdown (or recession) which would normally reduce demand, commodity prices are being driven up by investors. This in turn will push up prices of household goods on top of the recent increases faced by individuals for foodstuff and energy items.
- Trade. Banks unwrite trade via the provision of trade finance to buyers and sellers. When banks are jittery about each other, they will decline to accept "collateral" from each other and thereby hit international trade.
- Funding. Banks are looking to shrink their lending and hoard cash [return of cash rather than return on cash]. As such, similar to mortgage lending, banks are concerned about commercial lending and will be seeking to scale back loans to fund companies. At the same time, the markets are proving unwelcoming to new commercial paper. Consequently, firms will find themselves struggling to borrow to fund existing operations, let alone expansion. This has a direct impact on jobs.
The shock-waves from this crisis will reverberate widely and not be contained within the banking sector. Be warned.