2008 credit crunch


World stock markets

–          Japan’s Nikkei index plunged 9.6 percent;

–          India’s benchmark index dropped 11 percent;

–          Brazil’s Bovespa index fell 6.9 percent; and

–          Germany’s DAX index fell to its lowest level since May 2005.

–          Korea’s Kospi index was down 20 percent for the week

–          U.S. markets was less pronounced — the Dow Jones industrial average fell 3.59 percent

–          Since Sept. 1, about $16.3 trillion worth of global stock market value has been erased.

Oil

–          Gloom about economic growth translated to low expectations for oil consumption. The Organization of the Petroleum Exporting Countries yesterday announced a cut of 1.5 million barrels a day in output — a move that still failed to arrest the slide in crude prices.

Copper

–          Meanwhile, copper prices fell to a three-year low.

–          China consumes more than one-quarter of the world’s copper supply, and a slowdown there has dampened world prices.

Dollar

–          Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar by pouring money into 30-year Treasury bonds, a refuge in times of uncertainty. That drove down the value of foreign currencies, from the ruble to the rupee and the zloty to the peso, forcing central banks to spend billions of dollars to prevent even further deterioration.

= Although a drop in oil prices has put more money into the hands of consumers worldwide, analysts fear that the shrinking size of stock portfolios and falling house values will constrain consumer spending anyway.

= Lower gasoline prices would act like a more than $150 billion stimulus for U.S. consumers. But that could be more than offset by a shrinking sense of wealth, especially among the top 20 percent of wage earners, who account for the bulk of equity investments and 40 percent of consumer spending.

= A credit squeeze can lead to a drop in U.S. spending, which can curb demand for Chinese exports, which can curtail demand for commodities.

Global Slowdown Emerging Markets

Global Slowdown Britain

Global Slowdown Asia Pacific

Emerging economies

–          scramble by emerging economies to prop up their sagging currencies and avert credit defaults.

–          In the late 1990s emerging-markets crisis, many of the countries with shaky finances were in Asia. Now many of them are dotted around Europe’s periphery. Countries such as Iceland, the Baltic countries, Hungary and Turkey ran up large foreign debts in recent years when credit flowed cheaply and easily. To different degrees, they’re struggling to repay or replace those debts in today’s dramatically changed world.

–         Investors around the world are withdrawing their money from countries whose economies are vulnerable to a disruption in the supply of credit. As they flee to the relative safety of a newly resurgent dollar, uncertainties grow about how many emerging-market countries may need rescues, and how badly.

–           Europe’s East has few banks of its own. Most are subsidiaries of large Western banking groups. Now that those are supported by their home governments, they are unlikely to let their Eastern units go bust.

Poland and Hungary

–          The Polish zloty and Hungarian forint had their biggest weekly declines.

–          On Wednesday, Hungary’s central bank had taken the dramatic step of raising interest rates by a steep three percentage points in order to prevent a run on its currency. The central bank’s steep lifting of already-high interest rates to 11.5% from 8.5% — against a recent tide of rate cuts elsewhere around the globe — didn’t significantly check the forint’s decline Wednesday. It fell 2.88% against the dollar, slightly less than some neighbors, contributing to a fall of nearly 10% so far this week and more than 21% so far this month.

–          A run on the currency threatens the businesses and households because the cost of existing debts is soaring, while banks are choking off new lending. Many Hungarian companies and consumers also have borrowed heavily in euros, Swiss francs and other foreign currencies, where they could get lower interest rates and against which the forint had done well for years.

–         Banks already are cutting back credit for small businesses and consumer purchases such as cars, fearing that debtors could struggle to repay as the economy sours.

–          Already, the European Central Bank has lent Hungary €5 billion to help its banks raise foreign-currency funds — unprecedented aid from the ECB for a country that does not share the euro currency it controls. But there’s no sign the loan helped to restore investors’ confidence in the country.

–         Hungary’s government, banks and companies need to repay or replace about €27 billion of debt to foreigners that falls due in the next 12 months. The country’s foreign-exchange reserves only come to about €17 billion, according to a report by Barclays Capital in London.

Estonia

–           Estonia is headed for a two-year recession and won’t grow again until 2010, its central bank warned Wednesday, a far cry from the Baltic nation’s roaring annual growth of more than 10% for years until 2006.

Mexico

–          Mexico bought $13.1 billion of pesos to keep the currency from falling further; it has had its worst decline since the country’s “tequila crisis” of 1994, when the United States put together a rescue package.

–           The falling currencies are a sign that investors are losing confidence in those countries, and it makes their imports more expensive.

Brazil

–          Brazil illustrates how indiscriminate the financial crisis has been in claiming victims. Unlike many nations, Brazil’s economy is relatively balanced, and its foreign borrowings have been relatively modest. Yet the country has still been squeezed by recent events. On Thursday, it eliminated its tax on foreign investments to remove an obstacle to capital inflows and bolster its currency, which has dropped 17.5 percent against the dollar this month.

IMF’s role

–          The IMF stepped up its efforts to contain the expanding crisis, agreeing to a $2.1 billion rescue program with Iceland, whose financial meltdown triggered big losses for German and British banks. Belarus, Pakistan, Hungary and Ukraine have also asked the IMF for emergency loans.

Compiled from WSJ and Washington Post.

  • French President Nicolas Sarkozy said he would suspend a tax on new investments by companies until Jan. 2010 to help stimulate the economy.
  • Germany’s finance ministry, which hastily approved a €500 billion rescue package for the country’s banking sector last week, said it doesn’t intend to match that with spending aimed propping up the economy, at least for now, because of concerns of deepening the budget deficit.

Britain

–          reported its first economic contraction since 1992.

–          The news that Britain is on the brink of recession contributed to a 5 percent drop on the London stock market. The pound dropped to $1.58, the first time it has dipped below $1.60 in five years.

–          “This figure is worse than we expected, with the slowdown spreading right across the economy,” said Richard Lambert, director general of the Confederation of British Industry. Manufacturing, construction and retail were all hit.

–          “This is the day the recession became real,” said David Cameron, the leader of the opposition Conservative Party. “We will get through this, but we need change to support small businesses; we need change to bring a more balanced economy.”

–          Heavy reliance on exports that has driven Asia’s powerful growth is now turning into the its worst enemy. Exports accounted for 46.7% of gross domestic product in Asia, excluding Japan, in 2007. That is a jump of 11 percentage points more than the comparable figure in 1998, during the last economic crisis in the region. In other words, Asia is now 30% more reliant on exports than it was less than a decade ago.

–          Feeble corporate profit reports

–          Sinking commodities prices

Japan

–          Japanese giants Sony and Toyota, as well as South Korea’s Samsung, the world’s largest maker of memory chips, flat-screen televisions and liquid crystal displays, posted weakened profits and sales outlooks. Toyota’s quarterly sales fell for the first time in seven years.

–          Canon, the world’s biggest maker of digital cameras, dropped 9 percent.

–          Japanese companies’ plight has been exacerbated by the resurgent yen, which rose faster against the dollar in the past week than it has in the past 10 years. The currency’s value is rapidly eroding the competitiveness of Japanese exports, which were already plummeting due to collapsing demand in the United States and Europe.

Korea

–          Samsung fell 14 percent yesterday alone.

–          The South Korean government has injected $130 billion into the country’s banks, but that failed this week to stabilize markets or prop up the country’s currency. Stocks have fallen about 35 percent this month, and the won continues to be the worst-performing major currency in the world, down about 35 percent against the dollar this year.

–          Much of the decline in the won and in Korean shares has been triggered by foreign investors pulling their money out of the country’s stock market. Foreign ownership of Korean stocks has fallen to less than 30 percent after peaking at about 42 percent four years ago, according to the Yonhap News Agency.

India

–          In India, television news channels called it a “black Friday” as bearish investors were undeterred by the run-up to the most auspicious Hindu festival of good fortunes, Diwali, which is Tuesday.

–          Lower consumer and corporate spending in the United States is likely to ripple around the world. “The global turmoil has had an indirect knock-down effect on India,” Duvvuri Subbarao, the governor of the Reserve Bank of India, said at a news conference at which he lowered India’s growth projection to 7.5 percent for this year. “Consequently, trade for emerging economies is becoming difficult.”

–          India’s rupee fell to a record low against the dollar.

China

–          “When you look at worldwide supply and demand, China is the gorilla,” said Charles Bradford, metals analyst at Soleil Securities. “Near term, it looks like there is no bottom to the [metals] markets.”

–          China has also trimmed the importation of other materials that have fueled its spectacular run of growth. Bradford noted that ocean freight rates for iron ore from Brazil to China are down to $12 per ton today from about $108 last May.

Compiled from WSJ and Washington Post

“We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads — the difference between what it costs the government to borrow and what private-sector borrowers must pay — are at historic highs.

This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. “The Fed,” she argues, “has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible.”

“In the 1930s, as Ms. Schwartz and Mr. Friedman argued in “A Monetary History,” the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they’d lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: “If the borrowers hadn’t withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress,” deepening the crisis and causing still more failures.

But “that’s not what’s going on in the market now,” Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers — “all these exotic securities that the market does not know how to value.”

“Why are they ‘toxic’?” Ms. Schwartz asks. “They’re toxic because you cannot sell them, you don’t know what they’re worth, your balance sheet is not credible and the whole market freezes up. We don’t know whom to lend to because we don’t know who is sound. So if you could get rid of them, that would be an improvement.” The only way to “get rid of them” is to sell them, which is why Ms. Schwartz thought that Treasury Secretary Hank Paulson’s original proposal to buy these assets from the banks was “a step in the right direction.”

“The problem with that idea was, and is, how to price “toxic” assets that nobody wants. And lurking beneath that problem is another, stickier problem: If they are priced at current market levels, selling them would be a recipe for instant insolvency at many institutions. The fears that are locking up the credit markets would be realized, and a number of banks would probably fail.”

How did we get into this mess in the first place? As in the 1920s, the current “disturbance” started with a “mania.” But manias always have a cause. “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.

“The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses.”

“The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan.”

“In general, it’s easier for a central bank to be accommodative, to be loose, to be promoting conditions that make everybody feel that things are going well.”

WSJ – Weekend Interview

Taken from Paul Krugman’s blog.

“…Three weeks before J.P. Morgan bought WaMu’s deposits for $1.9 billion, officials at the Federal Deposit Insurance Corporation had called J.P. Morgan to say that the FDIC was carefully monitoring WaMu and that a seizure of its assets was likely…

…J.P. Morgan had known for three weeks that if WaMu was seized, and J.P. Morgan won the assets, the big bank would want to raise enough capital to keep its Tier 1 capital at at least 8%. Tier 1 capital is the gauge of a bank’s health watched by regulators, and it measures whether a bank has sufficient capital to cushion future losses. The federal government requires a minimum Tier 1 ratio of 4%, and 8% is typically thought to be robust. J.P. Morgan’s plan was to gather $8 billion in one big capital-raising, which would put its Tier 1 ratio between 8% and 8.5%.

It is not, however, easy to raise $8 billion of capital without revealing why. J.P. Morgan could not risk revealing anything about WaMu’s potential seizure, or face the FDIC’s wrath and a major market disruption. So the bank chose a strategy that has become increasingly popular in these times of crisis: “wall-crossing.”

Here’s how it worked. J.P. Morgan picked 10 major financial firms that could help the bank raise money. None were sovereign wealth funds or private equity firms, according to people familiar with the situation; all 10 were U.S. asset managers, and several were already among the list of the biggest J.P. Morgan shareholders. Some of the firms — who remain unnamed — also helped Goldman Sachs raise billions of dollars last week.

J.P. Morgan’s bankers called the 10 chosen firms and posed a question: the bankers were advising a U.S. bank that was contemplating a strategic acquisition of a retail bank, and a capital-raising could be connected. The bankers could not reveal their client until the bidding was done. Did the investors want to hear more? If they said yes, they would get details; if they said no, they would be left out in the cold on a deal that could potentially move the markets.

Nine of the 10 investors that J.P. Morgan invited said they were interested in hearing more. As soon as they agreed, they were asked to sign confidentiality agreements that would make them official J.P. Morgan insiders, which would mean that they could not trade in the bank’s stock. J.P. Morgan’s CEO, Jamie Dimon, along with CFO Mike Cavanagh and retail chief Charlie Scharf triple-teamed to speak with the investors in half-hour conference calls that extended throughout the day on Thursday. The investors were told that the U.S. bank in question was J.P. Morgan itself. Some of the investors independently guessed that the takeover candidate was WaMu, but none knew that a potential seizure of WaMu’s assets was in the works, nor did J.P. Morgan tell them.

By the end of the day, J.P. Morgan had raised $7 billion from the nine investors. By 9:15 p.m., when J.P. Morgan held its public conference call to announce the deal, all seven investors were taken off the “insiders” list and no longer had any access to material non-public information about the bank. J.P. Morgan also planned to raise another $1 billion in the capital markets on Friday by opening the offering to anyone who wanted to participate. Meanwhile, Dimon repeatedly touted the effort as an “offensive” one, painting the capital-raising as an effort to get ahead while other banks, he indicated, were just trying to keep up…”

WSJ – Deal Journal, September 29.

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