'The US economy is about to suffer a painful dose of reality. About time, too
The Bear Stearns collapse heralds the end of the culture of easy lending - and it won't be just America feeling the heat
Bill Emmott
The Guardian,
Tuesday March 18 2008
The Bear Stearns collapse heralds the end of the culture of easy lending - and it won't be just America feeling the heat
Bill Emmott
The Guardian,
Tuesday March 18 2008
This article appeared in the Guardian on Tuesday March 18 2008 on p38 of the Comment & debate section. It was last updated at 01:23 on March 18 2008.
The collapse and fire sale of Bear Stearns, the fifth-largest US investment bank, may seem bad news, but it is actually good. The excesses of Wall Street firms in recent years were so egregious that a shake-out simply had to happen. Since the credit crunch became manifest last August, we have in effect been waiting to see some blood spattering on to those broad investment-banking braces. It would have been a travesty - and rather surreal - if we had had to wait much longer.
Whenever financial crises have occurred - such as in Britain in the early 1970s, America in the late 1980s or Japan in the early 1990s - the vital moment has been the one when reality strikes home. All the talk last autumn and early this year of merely mild global economic slowdowns, of modest adjustments in business practices by the banks, was a sign on both sides of the Atlantic that the moment still lay ahead. The fall of Bear Stearns suggests it is now here.
And what a fall. For a powerful investment bank to be worth just $2 a share in the hands of its purchaser, JP Morgan Chase, when it had supposedly been worth $36 only last Friday and as much as $158 last April, shows the true nature of risk in buying equities. This was the biggest Wall Street collapse since Michael Milken's Drexel Burnham Lambert took its junk-bond tumble in 1990.
JP Morgan, a venerable US name but in recent years one of the less reckless, has got a bargain because the Federal Reserve, America's central bank, is lending it enough money to cover Bear's most troubling liabilities. But the Bear Stearn shareholders have been more or less wiped out, which is what should have happened last September in Britain when Northern Rock ran into trouble.
The demise of Bear Stearns had similar roots to that of Northern Rock. Bear borrowed huge sums on the short-term money markets to trade and invest in long-term, illiquid assets (in the Rock's case mortgage loans, in Bear's case mortgage-backed securities and other fancy bits of paper). So when other banks grew queasy about its credit-worthiness and started to demand much higher prices for their money, its losses began to mount, even as the value of its long-term assets was plunging.
Reality, however, is wider than just one firm. It should be welcome that the shake-out has got going, but there are soon likely to be other casualties. The biggest and most important casualty, though, is going to be the culture of easy lending to companies and to households that has lain behind America's economic growth in the past six or seven years. As a result, even if the Fed cuts US short-term interest rates again today by three-quarters of a percentage point or even a drastic one percentage point, credit conditions in America will still tighten.'
Whenever financial crises have occurred - such as in Britain in the early 1970s, America in the late 1980s or Japan in the early 1990s - the vital moment has been the one when reality strikes home. All the talk last autumn and early this year of merely mild global economic slowdowns, of modest adjustments in business practices by the banks, was a sign on both sides of the Atlantic that the moment still lay ahead. The fall of Bear Stearns suggests it is now here.
And what a fall. For a powerful investment bank to be worth just $2 a share in the hands of its purchaser, JP Morgan Chase, when it had supposedly been worth $36 only last Friday and as much as $158 last April, shows the true nature of risk in buying equities. This was the biggest Wall Street collapse since Michael Milken's Drexel Burnham Lambert took its junk-bond tumble in 1990.
JP Morgan, a venerable US name but in recent years one of the less reckless, has got a bargain because the Federal Reserve, America's central bank, is lending it enough money to cover Bear's most troubling liabilities. But the Bear Stearn shareholders have been more or less wiped out, which is what should have happened last September in Britain when Northern Rock ran into trouble.
The demise of Bear Stearns had similar roots to that of Northern Rock. Bear borrowed huge sums on the short-term money markets to trade and invest in long-term, illiquid assets (in the Rock's case mortgage loans, in Bear's case mortgage-backed securities and other fancy bits of paper). So when other banks grew queasy about its credit-worthiness and started to demand much higher prices for their money, its losses began to mount, even as the value of its long-term assets was plunging.
Reality, however, is wider than just one firm. It should be welcome that the shake-out has got going, but there are soon likely to be other casualties. The biggest and most important casualty, though, is going to be the culture of easy lending to companies and to households that has lain behind America's economic growth in the past six or seven years. As a result, even if the Fed cuts US short-term interest rates again today by three-quarters of a percentage point or even a drastic one percentage point, credit conditions in America will still tighten.'
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