Aug 24 2007
'Credit crunch' became phrase of the month in the media in August as stock markets around the world fell and rose as the effects of poor sub-prime lending in the US spread.
At its lowest, the FTSE fell 4.1 per cent, its worst day in over four years, while Dow Jones and other indices followed suit.
Initially, before the events of the last two weeks, many experts predicted the effects of the sub-prime crisis would be limited to the US and those hedge funds that invested in sub-prime debt.
However, the lack of visibility in the hedge fund market, seen by many as its benefit, also led to insecurities on the markets with investors being unsure where losses exactly fell, and those with burnt fingers slowly started to appear.
As uncertainties increased, banks started to ease up on lending to investors and among themselves leading to the 'credit crunch' becoming 'liquidity crunch'.
In Germany, two banks - IKB and Sachsen - were forced to ask the Bundesbank for an emergency rescue package because of losses faced and €17.3 billon has been provided by the central bank to other banks through its credit facility.
In the UK, Halifax Bank of Scotland has announced that it is to step in to repay about $35 billion of commercial paper owed by its Grampian Funding division, following the instability.
However, moving on - thanks to help from central banks providing liquidity to the markets and the Federal Reserve cutting it is discount rate along with a $3.75 billion injection into financial system - the markets have stabilised. Barclays was forced to borrow £314 million from the Bank of England through its emergency credit facility and similar loans of $500 million were given to Citibank, Bank of America, Morgan Chase and Wachovia from the Federal Reserve. The European Central Bank added emergency funds of €98.4 billion.
Threadneedle Leigh Harrison's weekly Blog takes us through the ups and downs on last week when the sub-prime trouble erupted as the FTSE saw falls and rises and falls as rumours and counter-rumours circulated, before an eventual cutting of the discount rate by the Federal Reserve to hold the markets.
Mr Harrison concluded at the end of the week: "No doubt things will bounce today because an air of normality seems to have returned but I remain suspicious - the news flow seems likely to unsettle the market a bit more before this whole adjustment is through.
"My view is that this will be a good thing because risk has been mis-priced for a while now and moving back to more normal spreads in credit markets is part of the process of tightening monetary policy because growth and inflation are rising."
Edmund Brandt, Investment Director at JPMorgan Asset Management, also takes readers through the week of uncertainties on both sides of the pond.
In JPMorgan week under review - Pacific he writes: "The week began solidly, with financial stocks recovering some ground as it was rumoured regulators would loosen restrictions on the amount of home loans [to] federal mortgage agencies."
However, by Thursday, Mr Brandt notes: "News that BNP Paribas had suspended three of its funds with subprime exposure sparked sharp global falls on Thursday, prompting the Fed to join the European Central Bank in seeking to stabilise markets with injections of liquidity.
"Intervention from the central banks was a mixed blessing, with some bearish investors taking it as further indication of a looming liquidity crunch. However, despite early losses following sharp falls in Europe, Wall Street stabilised on Friday after further cash injections, with financial stocks managing to hold on to some of the week’s gains."
On this side of the Atlantic, Mr Brandt explains what happened in JPMorgan Weekly Stock Market Report
"Financials were battered by concerns that several European institutions may be sitting on large subprime losses. These concerns grew after BNP Paribas, France's largest bank, announced it was freezing three of its asset-backed investment funds due to a ‘complete evaporation of liquidity’ in the credit markets," he explained.
"Faced with such nervousness, many banks themselves were unwilling to lend to each other in the money markets, forcing overnight interest rates sharply higher to a peak of 4.6 per cent - their highest level in six years."
Mr Brandt went on to describe the insecurity that surrounds the market, although is upbeat to a degree: "Investors are now asking - when will the markets stabilise? While no one can predict the bottom, it's clear that many stocks are now trading below fair value and selling at these levels may lock in needless losses.
"Furthermore, European equities continue to be well supported by robust economic growth and improving corporate earnings growth. Therefore, those investors that have the ability to ride out the current volatility may be rewarded in the longer term."
Looking forward, Threadneedle chief investment officer Sarah Arkle, in Threadneedle Investment Strategy , sees the current problems as more financial than economic.
She writes: "The slowdown in the US housing market has been widely talked about for a number of months but it was hoped that its impact had been contained. The demise of a couple of hedge funds caused by exposure to sub-prime mortgage debt and the ripple effect into other areas of the US mortgage market has questioned that view.
"However, at present the impact of difficult trading conditions in credit markets caused by the uncertainties within the US mortgage market remains primarily a financial problem rather than an economic one."
Ms Arkle goes on to predict sub trend growth for the US in the medium term but the continued strong performance of China and Europe keeps global growth at healthy levels. UK GDP forecasts have also been upped.
"Nervousness in the credit markets has had a knock-on effect on government bonds where yields have fallen towards the low end of our projected trading ranges. This move does not reflect the views being expressed by central banks, which have remained hawkish in tone with the Fed still talking about inflation being at 'elevated' levels and therefore the situation is not conducive to a cut in rates," she writes.
Sebastian Mackay, senior economist at the SWIP bonds team predicts a limited impact on the real economy of the credit crunch.
In SWIP Global Economic Prospects Monthly, he writes: "The recent re-pricing of risk in credit markets is part of the general tightening of global financial conditions. However, the impact on the real economy and risk assets in general should be limited, given that overall financial conditions are still not particularly restrictive."
He added: "Continuing problems in the US housing market have fed through to a sharp widening of credit spreads and a sell-off in risk assets generally, raising fears of a 'credit crunch'.
"Until recently, though, an optimistic consensus on the global economy had emerged in which the US economy was rebounding while other economies remained unaffected by the previous period of US weakness. Our view lies somewhere in between."
Looking forward out of the crunch's uncertainty, traders are remaining circumspect and unwilling to say all is well, but while seas ahead are still expected to be choppy the consensus is that the worst is over, although the free credit that has been accessible for some time may not be so readily available.
