Expensive debt turned greed into fear
by Edmund Conway
It's a small world after all. It's a small, small world. We're all connected. If things get bad enough, maybe we'll all agree on a single currency. You know, for world peace.
Conway:
"Our financial system has a very nasty dose of flu. It started as a sniffle in the US, but now things are looking grim throughout the English-speaking world - particularly the City of London. Worse still, the consequences are likely to be felt by every family in the country.
Yesterday the London Stock Exchange's benchmark FTSE 100 index had its worst day in half a decade, wiping millions of pounds off the books of investors. The FTSE 250, an index that includes many of Britain's household names such as Carphone Warehouse and Debenhams, had its worst day in history.
The misery is not limited to businesses: Nationwide is reporting that house prices have stalled, the disposable incomes of British households are falling and cash-strapped families are being forced to dig into savings to keep their finances afloat."
Just like here in the good ol' U. S. of A., the Brits have discovered the joys of overextending themselves financially. It's fun at the start...ooh shiny motivates many a stupid and unnecessary purchase.
"Some City experts call it a "credit crunch"; others a "credit chill" or a "debt downturn", but none of these epithets captures the sheer sense of doom in the markets right now.
Not only are share prices in both London and New York suffering, some people are worried that as businesses struggle, they could start to slash jobs and freeze wages.
At the heart of all this woe is a simple four-letter word. Debt."
Ya think?
"The debt that fuels the financial system - the very backbone of capitalism - has suddenly dried up. Lenders, who for so long were willing to hand out money at historically low interest rates, have rediscovered their sense of risk. Fear is taking pre-eminence over greed."
That's right. Debt, not production and consumption, is the backbone of capitalism. Capitalism is about capital, not productivity.
"It is a rude awakening. It has been extremely cheap to borrow in recent years - both for companies and individuals. The rock-bottom mortgages consumers enjoyed in Britain are only one manifestation of this global phenomenon.
Just as the rates on home loans plumbed new depths two or three years ago, the levels at which banks and businesses have been borrowing were also historically low.
This cheap debt has helped push house prices to their recent peaks and enabled private equity firms to raise the cash to buy out big companies such as the chemist chain Alliance Boots.
Why is this news to anyone?!
No one was seriously suggesting this build-up could go on for ever. But no one could predict the trigger that would cause the foundations of this debt mountain to shudder.
They did not reckon on a severe housing market slump in the US. Some American mortgage companies have gone bust after their customers failed to keep up with their payments.
These apparently local issues have reminded banks across the world what happens when debt goes wrong. Suddenly, in recent weeks, they have decided it no longer makes sense to lend cheaply with such gay abandon - to anyone."
Uh oh. Credit crunch on the way.
"This realisation has been a painful one for the City. The banks that have signed up to fund expensive corporate takeovers are facing the prospect of taking a hit in order to get the deals through.
The sales of Chrysler in the US and Boots in the UK to private equity buyers are stalling since no one wants to stump up the debt needed to get the deals through. The prospect that billions of pounds worth of major deals could go belly-up is what has spooked the markets this week.
Experts fear that a similar episode to the US mortgage blow-up could take place here. With interest rates having risen to a six-year high of 5.75 per cent, householders who negotiated attractive two-year deals on their mortgages in the second half of 2005 are facing a sudden increase of one-third in their bills."
Collective buyer's remorse hitting the US will spread to the UK. Again, who is surprised by this?
With the Government just as indebted as the public and corporations, the list of people the economy can turn to to keep it afloat is shorter than ever.That said, there are reasons to remain optimistic. Share prices may have fallen, but they did so from extremely high levels. Households and businesses will have to stomach more expensive loans, and that will be painful for some.
But the financial system is sophisticated enough to survive this scare. Significantly, the world economy is still growing rapidly - thanks in large part to a resurgent Europe and a booming China. Likewise, central banks such as the Bank of England are ideally placed to ensure there is no repeat of the house price crash of the early 1990s.It is all too easy to overstate the severity of the current problems. As the old adage about sniffles goes, children get colds, men get flu and women get on with it. Macho markets are apt to make a lot of fuss when, fundamentally, they remain in rude health.
Those whiny Macho Men just can't handle a little discomfort. Get on with it!
