How Bad Can The Crunch Get?
Talk of financial meltdown is doing the rounds again, following huge losses at the world's biggest bank.
The revelation of further sub prime losses at America's biggest bank, Citigroup, and the ousting of its boss Chuck Prince, has sparked a return to panic-mode with traders proclaiming the arrival of Nightmare on Wall Street II.
In fact, the credit squeeze has not restarted for the simple reason that it never went away. The only fundamental change between August and now is the size of the potential losses being slated. Citigroup alone has now owned up to $17bn, making the once apocalyptic-sounding total of $200bn no longer seem so far-fetched as it did in the summer.
Indeed, a frightening new phase seems to be dawning: one of possible $1 trillion losses. Liquidity is drying up again; volatility is increasing; and the unknown horrors lurking in the debt-ridden structured investment vehicles (SIVs) affiliated to banks, continue to be a sword of Damocles hanging over the market.
This undoubtedly the worst financial crisis the world has faced for 30 years – the final nail in the coffin of the conservative free-market world view. We're in unchartered and dangerous territory. It isn't just the credit crunch that's worrying – though when banks stop lending it has a dramatic impact on growth – so much as its coincidence with a host of other negative factors, including an oil price approaching $100 a barrel.
To get through the crisis, the American and British governments are going to have to think what hitherto would have been unthinkable: they must intervene. Already the Americans are cutting interest rates regardless of the inflationary consequences. Britain may have to follow suit. Both governments will have to devise new forms of regulation and control.
But we must be careful not to over-egg the disaster, particularly since the crunch has yet to bite on the UK's wider economy. The Bank's chief economist, Charlie Bean, claims it's still difficult to assess the impact with any degree of precision. Others, noting continued good growth, insist the crisis is a blip and are urging the Bank to hold it's nerve on interest rates.
So long as the banks refuse to come clean on their liabilities, the system remains in danger. Financial markets are always fragile, but at present they are more than usually vulnerable to an outside shock. What could that be? Further meltdown in the US house market, another surge in the oil price, the sudden bursting of China's stock market bubble... Take your pick.
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