March 17, 2008
The Federal Reserve’s decision to give a $200 billion loan to the US banking system does not signify the end of the credit crisis.
When the awkward pre-business meeting chit-chat between strangers is dominated by the identity of a call girl, you know you have a huge story. Last week in New York, St Patrick, Barack Obama and the plunging dollar were all pushed out of the headlines by Eliot Spitzer.
Every taxi and dinner table conversation was humming with speculation about the New York governor’s antics with a call girl. The typically unflappable New Yorkers seem shocked, which in a city of vice – where everything is available and everyone has their price – is quite something.
The price of the dollar, the volatile stock markets and the reaction to the Federal Reserve’s most recent mega-bailout of the banking system with a $200 billion loan, lagged – even in Wall Street – a distant second to the governor, the Mayflower Hotel, ‘client 9’ and Kirsten, the call girl.
However, one thing is immutable in the US, and that is St Patrick’s Day. If any of us Irish, born in Ireland, want to see the potential power of the diaspora, come to New York for St Patrick’s weekend.
Tomorrow the city is ours and, despite all the small-minded chatter in Dublin about the cost of politicians’ visits to the diaspora, anyone with half a commercial brain can see that, in an era of ‘soft power’, the Irish network, contacts and financial muscle around the world is an invaluable economic asset for the motherland.
Now that it is finally dawning on people that the slowdown in the economy is severe and might be prolonged, an Irish plan B is necessary.
The demographic echo of our emigrant past, the millions of ‘hyphenated’ Irish are our best resource who are willing to be tapped as the biggest potential sales force the country has. For us at home, it is only a matter of having the vision to see them as a resource.
Like all new ideas, plan B – the notion of re-energising the diaspora – will become more logical in the context of a crisis. Last week, both at home and abroad, the extent of the financial crisis and the redundancy of the old ‘buy now, pay later’ model of growth was being exposed. So too were the limitations of the rather Catholic approach to financial responsibility that the Federal Reserve has decided to follow.
An interesting way and, in the context of St Patrick’s Day, an appropriate way to look at recent financial history in the US is to think of confession. Corporate America is behaving like a sinner, and Ben Bernanke – the head of the Federal Reserve — is behaving like a parish priest in the confessional.
For years, the US banking sector was being warned that overspending and over-borrowing was the path to financial delinquency. Yet the banks in the US and more egregiously, in Ireland, ignored the warning. Those who spoke out were referred to, bizarrely, as unpatriotic.
All this has changed and now the errant banks are acknowledging their sins. In the US, rather than the puritanical ‘repent or be damned’ approach, Wall Street is adopting the more Catholic ‘bless me Father for I have sinned’ tack. Bernanke – like a good priest – responded to these acts of contrition with the monetary equivalent of three Our Fathers and a Hail Mary and granted absolution, most recently last week in the form of a $200 billion bailout.
Unfortunately, as this was the fifth time the sinners had gone to confession since August, the pardoning power of the priest is being questioned. No one believes that the financial crisis is over. Nor do people accept the word of the priest anymore. We have reached ‘bailout fatigue’.
The last time we witnessed anything like bailout fatigue from the financial markets was in July 1998,when the International Monetary Fund (IMF) issued a $10 billion loan to Russia to assist the delinquent Yeltsin government, as a result of an economic crisis that had been building for months.
Gullible market players took this loan as a sign that the corner had been turned. They contended that such intervention could only stabilise things.
In contrast, I got a call that morning from an old market hand who had seen it all before and who told me: ‘‘sell everything, this is your last chance’’. He was on the money -Russia defaulted three weeks later. There was an eerily similar reaction in world financial markets to the Fed’s $200 billion bailout.
The Fed, worried that this credit crunch was not easing, pledged to inject money into the system to try and bring down interest rates. Normally, such a sign of official muscle would be enough to steady nerves, but these are not normal times. The opposite occurred.
Investors regard the Fed’s intervention as either a sign of panic or a sign that the balance sheets of banks were much ropier than even the most pessimistic bear had imagined. As a result – after an initial rise in prices – the intervention prompted a sell-off, confirming the suspicion that we are not out of the woods yet, by any means. This was emphasised on Friday when emergency funding had to be provided for Bear Stearns, the big Wall Street bank. The news sent the US stock markets tumbling again.
As we noted a few months back, the catchphrase in the banking world is now ‘‘guilty until proven innocent’’. This was the cause of Bear Stearns’s problems: it couldn’t raise funds because investors were hearing rumours that it was in difficulty.
Everyone knows that there is more horrible sub-prime and other derivative related crud on the balance sheets of some large banks, but because the banks have been evasive, no one knows for sure where the toxic stuff is. So the essential lubricant of the financial system – liquidity – has dried up, because trust has evaporated. You lend to people you trust and, if you don’t trust them any more, you demand a higher risk premium for the pleasure of lending them cash.
This ephemeral quality – trust – is what the central banks are trying to resuscitate. The financial markets arena has become a large game of pass the parcel. No bank wants to be the one that lends to the other bank with the huge sub-prime losses. The banks are desperately trying to pretend that they trust each other, while at the same time minimising the potential risk of any inter-bank loan, by trying to lay off that risk to someone else.
When everyone was confident, there were lots of banks happy to ensure that the system of loans, repackaged loans and syndicated loans worked well. But now the chain has broken, and the central banks are finding that trust is an expensive and elusive commodity.
Even Father Bernanke – the most benign, forgiving priest on the block – has lost his powers. There is a real sense this St Patrick’s weekend in New York that the financial markets, like Spitzer, are beyond redemption.